Prices as information transmitters

Lynne Kiesling

Last week on vacation we stayed in a paddle-in cabin 20 miles northeast of Ely, Minnesota. No phone, no television, no computer, hence no information on the horrific consequences of hurricane Katrina.

We ventured into town twice for dinner, once on Monday (when we saw a newspaper and saw the looming threat) and once on Wednesday. When we first drove into town on Saturday, gas was $2.54/gallon. On Monday it had increased to $2.59. On Wednesday it had increased to $2.99.

As soon as I saw the 40-cent increase, I said “the hurricane hit the Gulf refineries”. Sure ’nuff, when we bought a paper we saw what had happened.

By the time we left the area on Friday, gas prices had increased to $3.29.

The severity of price spikes like this reflects the magnitude of the shock (including the transportation time to such far away places), and the integration and sophistication of global energy markets to transmit that much information that quickly. It also reflects the consistent tendency to form expectations of the worst case scenario. If that worst case is not realized, as it was not in this case, prices tend to decline. To the extent that the price spike persists, it could do so because of uncertainty about just how bad the refinery damage is, as well as underlying scarcity.

Anecdotally, I have heard that $3+ gasoline induced dramatic curtailment in driving over the weekend. Some people wonder what it takes to get people to drive less; now we have some more information on that. Furthermore, retail prices have started to fall since Monday.

Bottom line: prices are very parsimonious, yet very sophisticated, transmitters of information about scarcity and expectations. They seem to have done their job in the past week.


4 thoughts on “Prices as information transmitters

  1. Price communicated; and, the message was received and understood. However, the whining about “gouging” is now full-throated. Nobody would really prefer to sit in line for hours; but, some think forcing the price down would help them somehow. Others just think the lines would allow them to further browbeat the President. Too bad very few are really interested in solving the problem – it’s not a “crisis” yet.

  2. The last time I checked, our “conservative” president was saying things like:

    “I think there ought to be zero tolerance of people breaking the law during an emergency such as this, whether it be looting, or price-gouging at the gasoline pump”

    Price Gouging may be against many state laws, but it certainly obeys the law of supply and demand.

    JBP

  3. Aeon,

    We low-balled the cuisine, went to Sir G’s for pizza and Cranberry’s for burgers. But that suited us fine! We were eating pretty healthily and cooking for ourselves at the cabin (and drinking the best $5-$9 wine to be had from Trader Joe’s), and our friend Amy was baking fresh bread. So we went for the barfood option in town!

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