The government of Hawaii just made a terrible mistake:
In an effort to gain some control over what motorists pay at the pump, Hawaii on Wednesday became the first state in the U.S. to set caps on the wholesale price of gasoline.
Economists have observed that setting below-market price caps on a good causes that good to become scarce. It has nothing to do with producers being greedy or petulant: Firms that produce the goods will just naturally lower their production when the sale price is lower.
The simplest explanation is the the lower sales price makes it impossible to earn a profit. If you’re running a factory that makes toasters for $25 each (parts, labor, taxes, insurance, maintenance, depreciation and everything else) and selling them for $35 each, a price cap of $24 will cause you to lose a dollar on each toaster. You’ll close the factory to avoid losing money.
Even if the price cap isn’t so low you can’t make money, let’s say $30, it could still impair your production. That’s because in reality, even though the toasters are identical, they don’t all cost the same to make. It might cost $25 to make a toaster during the regular shift, but if you give your workers some overtime, the price could shoot up to $32. At that cost, it’s still worth selling toasters for $35, but if the sale price is capped at $30, you can’t make money with overtime labor, so you’ll reduce your employees’ hours and toaster production will drop accordingly.
This can affect an amazing array of decisions that affect the final production figures. If your factory needs periodic maintenance, your decision about how large a maintenance crew to use, and therefore how fast the maintenance is done, is affected by the lost profit from the toasters that won’t get made while the factory is shut down. If a lower sales price means lower profits, you may let the factory stay idle longer. Again, production drops.
(By the way, if you’re wondering why you can’t just re-tool your factory to make the exact same toasters for, say, 20 dollars, the answer is that it’s not possible. If it were, you would have already done it so you could get that extra $5/toaster profit.)
Gasoline production is the same way. If someone caps the price of gas below the free-market price, production will fall. Again, greed has little to do with it. It will be things like older high-cost refinery facilities that stop production, or shipyards that cut their labor costs by cutting overtime for repairing oil tankers.
If the free market price bumps up against the caps, gasoline production in the Hawaiian islands will drop.
Does this mean Hawaiian motorists will soon be facing long lines at the gas pumps like we all did during the price freezes in the 1970s?
The cap, you see, is on the wholesale price of gas, not the retail price. Thus, there will still be shortages, but it will be the gas station operators who will be waiting in line for gas. Well, maybe not literally, but they’ll be having a hard time getting as much gas as they used to.
This means that they can’t sell as much gas as the motorists want. They’ll start to run short. But unlike their suppliers, they don’t have price caps. So as the gas supply starts to dwindle, they’ll raise prices on the remaining gas. Why? Because they can. Motorists will be desperate for gas and willing to pay more. You can call this greed if you want to, but they’ll only be charging what people are willing to pay.
As gas prices go up, some motorists will buy less gas. (They’ll ride the bus more, or walk, or consolidate trips, or drive the SUV less, or carpool, or something.) Eventually, the price will reach the point where motorist demand drops to match the reduced supply.
Now think about this. “In an effort to gain some control over what motorists pay at the pump,” Hawaii has just passed a price control system that will increase the price at the pump.
People who know what Adam Smith really wrote about the free market will by this time begin to suspect the these price controls are somehow the work of lobbyists for Hawaiian gas station owners. I’m almost sure they’re right. If station owners colluded to increase profits by restricting the supply of gasoline, they could be fined or jailed under the anti-trust laws. But if they lobby the legislature to do it for them, it’s perfectly legal.
It won’t last, though. Unless the Hawaiian legislature comes to its senses real soon, the public will start to demand retail price controls because of all the high gas prices.
Then there will be long lines at the gas pumps.
Update: The market has spoken.