The usual — and wrong — way to think about prices is that they determine how much money the buyer has to give up, and how much money the seller gains. Although that’s true, it’s not really the function of prices.
Prices tell all of us how scarce the resource is. High prices tell us: This item is really scarce, so conserve it. Low prices tell us: This item is abundant, so use it liberally.
Jeffrey Dorfman wrote a pretty good article for Forbes last fall, but he portrayed the issue as consumer versus business. That’s not entirely true.
In a disaster, we want consumers to conserve the scarce resources. Say that bottled water is needed but not widely available. Joe Consumer walks into a store looking for one case and sees two cases left, selling for the usual price.
He might buy both just to be safe. So when Jill Citizen walks in, none are left. Keeping prices low sends the wrong signals to consumers. It helps one consumer with low need at the expense of another.
Two hundred miles away, Fred Sharp hears about the bottled water shortage and thinks about loading up his pickup truck at a warehouse store to make a profit selling water in the disaster area.
That’s the signal we want entrepreneurs to get: Deliver water. But his efforts wouldn’t be profitable if he were at risk from an anti-price-gouging law.
The point here is that prices are a signal to both buyers and sellers. Prices convey information. Keeping the information flowing is vital to keeping important goods and services flowing.