Question

Using the example of the gasoline market, explain how price acts as a rationing tool. Are there other ways to ration gasoline among consumers? Explain.

Answer 1

The interaction of buyers and sellers in free markets enables goods, services, and resources to be allocated prices. Relative prices, and changes in price, reflect the forces of demand and supply and help solve the economic problem. Resources move towards where they are in the shortest supply, relative to demand, and away from where they are least demanded.

Whenever resources are particularly scarce, demand exceeds supply and prices are driven up. The effect of such a price rise is to discourage demand and conserve resources. The greater the scarcity, the higher the price and the more the resource is rationed. This can be seen in the market for oil. As oil slowly runs out, its price will rise, and this discourages demand and leads to more oil being conserved than at lower prices. The rationing function of a price rise is associated with a contraction of demand along the demand curve.

An incentive is something that motivates a producer or consumer to follow a course of action or to change behaviour. Higher prices provide an incentive to existingproducers to supply more because they provide the possibility or more revenue and increased profits. The incentive function of a price rise is associated with an extension of supply along the existing supply curve.

As a rule, economists are against rationing, as it distorts consumer choices, fosters underground markets, and nurtures corruption. But the alternative -- the market solution -- may be ugly. It will quickly cut the length of lines as gasoline prices skyrocket, but will penalize low-income people, who still need this basic product to drive to work or take other necessary trips.

Obviously, rationing may be the lesser of two evils, especially in the current gasoline shortage situation -- where the problem is the limited number of sales points rather the limited supply of the product.

But should government set the rationing rules, or leave this task up to customers and gasoline stations? the second solution is better than the first, simply because government doesn’t have full information for each local market—the participants do.

Governments should create the conditions that accommodate trade; and let business and consumers determine the parameters of the trade.