Let Prices Rise

Supermarkets shelves are empty. Groceries are stocked out. Alcohol-based sanitisers have been missing from racks for a few days now. Even medical masks which generally would sell for Rs 6-10 per piece are being sold for up to Rs 100 a piece. As India enters into the third stage of transmission of COVID-19, we need high quantities of testing kits to identify patients and contain community transfer. Hospitals need ventilators for admitted patients. 

Sensing the shortage, the Union government announced price caps masks and sanitisers on March 20. The price ceiling would be valid until June 30. The statement said that a three-ply (surgical) mask wouldn’t sell for more than Rs 10, a two-ply (surgical) would go for a maximum of Rs 8 and 200 ml hand sanitiser bottles not more than Rs 100 per bottle.

The gouging of prices of goods in times of crises is not unprecedented. We have seen this multiple times, perhaps not to this extent, in our lives during floods, earthquakes, and tsunamis. During the Second World War, as the demand for munitions rose, the prices of civilian goods in the United States began to rise. Price controls imposed on essentials led to the emergence of black markets and the breaking of the law.

Some say, perhaps rightly, that people who are buying three bottles instead of one are selfish and inconsiderate towards the requirements of others. While we may concur or differ on the true nature of the humankind, the point that this piece is trying to make is that ignoring incentives even, nay especially, in these uncertain times would be foolhardy. 

Unseen effects of price controls

While the price-caps may seem to bring relief to the consumers and may have arisen out of good intentions, they have many unintended consequences. Ironically, the poor people, who the government aims to protect from rising prices, suffer the most. In a setting where the prices are capped, the supply of sanitisers and masks would be finite and limited. Since the demand for the products would remain high in light of the threats from the virus, people would buy more than their requirement, given the reasonable prices. Since the rich tend to be better informed, they would end up having collected more products in this first-come-first-serve model. Inevitable shortages caused due to price controls, coupled with the information asymmetry in the market would leave the less privileged much worse off.

As Professor Alex Tabarrok of Marginal Revolution University explains, price is a signal wrapped up in an incentive. This signal influences behaviours impacting both the demand and the supply. As individuals/households, all of us encounter multiple alternatives and make numerous choices based on our needs, and constrained by the size of our wallets. In a time of crises as today, if I am faced with the option of using my monthly budget to buy a new shirt versus masks and sanitisers, I would choose to buy masks to protect myself. Higher prices would dis-incentivise me from stockpiling.

Just as consumers face multiple choices, producers use their means of production (land, labour, capital) to manufacture different types of goods. If a factory owner observes that the prices of sanitisers have increased, he would understand that sanitisers have become scarce and reallocate resources from other products towards producing sanitisers. The scarcity of sanitisers and masks would motivate producers and retailers to explore opportunities to import these products from countries which produce more efficiently, have more production than their internal requirements and are willing to trade. The scarcity would also encourage an inventor or an entrepreneur to research and develop substitutes. The signal of scarcity and the possibility of gaining a profit would incentivise the producer to put his resources to the best possible use. 

These invisible interactions between the buyers and sellers in a marketplace would balance the demand-supply mismatch and bring it to equilibrium. These kinds of small, decentralised decisions by millions of rational individuals according to their information, is how the market efficiently provides the products that consumers need. 

We have already started to see this happen. IIT Delhi published on its LinkedIn page that the Department of Chemistry has developed hand sanitiser compliant with WHO guidelines using three chemicals along with Aloe Vera and ~75 percent isopropyl alcohol. Anand Mahindra declared on Twitter that Mahindra Group would begin work on how its manufacturing facilities can make ventilators. FMCG giant HUL has also announced that it will scale up production of Lifebuoy sanitizers, Lifebuoy hand wash liquid and Domex floor cleaners.  

While implementing price caps on essential products may be well-intentioned and seem compassionate, such caps would lead to shortages. Unavailability of essential goods would hurt the poor and the vulnerable the most. While these are trying times for us as a community, country and kind, we would do ourselves a disservice by abandoning basic economic and behavioural reasoning.