Economic Shortage

Updated About encyclopedia.com content Print Article Share Article
views updated

Economic Shortage

What It Means

An economic shortage occurs when sellers do not make enough of a product to satisfy those who want to buy it at a given price. A common reason for a shortage is that the price of a good is too low: as prices fall, sellers lose the incentive to sell goods because their profits decrease, whereas buyers are increasingly willing to buy products because they save money. In a market economy, in which decisions about selling, buying, and pricing goods are made by businesses and consumers rather than being imposed by governments, economic shortages tend to be eliminated naturally.

If, for example, a clothing company introduces a new line of jeans selling for $25 a pair, and stores immediately sell out of the initial production run of 10,000 pairs, the company, realizing it could make more money, might raise the price of jeans to $35, at which price it would be willing to manufacture 20,000 pairs. If these, too, sell out immediately, the company will raise the price still higher, and so on, until its willingness to supply jeans matches consumers’ willingness to buy them. In this way, market economies avoid economic shortages.

But if the price of jeans were to rise so high that ordinary people could no longer afford them, the government could intervene to keep jeans affordable. It could institute a price ceiling, declaring that no company can charge more than $25 for its jeans. Faced with limited profits, however, the company may be unwilling to manufacture more than 10,000 pairs, even though 50,000 people want to buy them at this price. In this situation the price ceiling has caused an economic shortage, which will continue to exist for as long as the government maintains the ceiling. People may have to wait in line for jeans, buy them on the black market (that is, illegally), or procure them through personal connections. If these problems become too intense, the government may seek to deal with the shortage through rationing. This would entail restricting the distribution of the jeans, perhaps by giving one group of people the right to buy jeans on certain days and another group the right to buy jeans on the remaining days.

Most economists agree that price ceilings are almost always a bad idea, because the problems caused by economic shortages are usually more numerous and troublesome than the problems the price ceilings were supposed to correct.

When Did It Begin

Economic shortages were found most commonly in planned or command economies, in which a central government or other authority sets prices and controls the amounts of goods and services that are produced. The world’s earliest civilizations, such as those in ancient Egypt, Greece, Babylon, and China, were characterized by planned economies. While planned economies are good at accomplishing large tasks, such as building the Egyptian pyramids or the Great Wall of China, they are not able to respond effectively to changes in supply (the amount of a good that sellers are willing to provide at a given price) and demand (the amount of a good that buyers are willing to buy at a given price). When demand is greater than supply, an economic shortage exists. In a planned economy fixed prices usually mean that shortages cannot be solved.

In the sixteenth through eighteenth centuries, planned economies began giving way to market economies (in which prices are determined through the interactions of buyers and sellers). Economics as a discipline emerged during the late eighteenth century, when people began to study how a market economy regulates itself. The understanding of supply and demand that economists have today was fully developed by the late nineteenth century, but this understanding did not result in the end of economic shortages. In a market economy such shortages are solved by market forces (supply and demand tend to adjust until they meet at an equilibrium point). Nevertheless, numerous factors, such as political goals, wars, and the desire to aid the poor, can lead governments to limit prices. Although this almost always results in economic shortages, most ordinary people do not think like economists. Instead, they welcome government intervention that limits prices, because it appears that such policies will simply help people save money.

More Detailed Information

In everyday life, people use the word shortage to describe any situation in which a group of people cannot buy what they need. For example, a lack of affordable homes is often called a housing shortage. In economic terms, however, this is not considered a shortage; in any market economy there will always be people who cannot afford certain products. The term economic shortage means something more specific; it is a situation in which people who want to buy a product at its current price cannot satisfy that desire. In other words, a shortage results from an imbalance between demand (how much of a product or service consumers want to and are able to buy) and supply (how much of that product or service is actually available for purchase).

In a market economy lowering the price of a good will typically cause an increase in the quantity demanded for that good, because more people can afford to buy it. On the seller’s side, lowering the price of a good generally decreases the quantity supplied, because sellers, knowing they will make smaller profits, will be less motivated to supply that good. When the price of a good is too low, a shortage results: buyers want more of the good than sellers are willing to supply at that price.

When markets are functioning properly, economic shortages should be temporary because prices theoretically move toward equilibrium, a point at which supply and demand are balanced. If there is a shortage, the high level of demand will enable sellers to charge more for the good in question, so prices will rise. The higher prices will then motivate sellers to supply more of that good. At the same time, the rising prices will make demand go down. Sellers will continue to increase prices until supply matches demand.

When economic shortages persist, it is usually because a central authority (in today’s world, a government) has imposed a price ceiling. A price ceiling is a maximum amount that can be charged for a particular product. During persistent shortages people must wait in line for products or pursue them through extralegal means, such as bribery or smuggling.

For example, in the former Soviet Union, which was founded in the 1920s with the intent of distributing economic benefits equally among its citizens, the government controlled prices and made decisions about how much of a given good to produce, and by what means. As the Soviet economy grew and modernized, it became common for the nation to experience shortages and surpluses (a situation where there is more supply of a good than demand for it). Ordinary citizens often had to wait in lines to acquire such basic necessities as cars, housing, and clothing.

While the United States embraces the market economic system more fully than most other developed countries, it too has used price ceilings throughout its history. During World War I (1914–18) and World War II (1939–45), it was common for consumer demand to outstrip supply. This happened because companies were devoting more of their resources to making war materials and less to making consumer goods. In response consumers rushed to stock up on goods, which caused prices to rise quickly. In order to keep prices from getting out of control, the government adopted price ceilings. Many economists believe, however, that the price ceilings worsened the imbalance between supply and demand, resulting in more severe economic shortages. During the first two World Wars as well as the Korean War (1950–53), the U.S. government had to use rationing to manage the problems caused by economic shortages, restricting the amount of goods people could buy and the frequency with which they could buy them.

If the government allowed prices to go up instead of imposing a ceiling, supply and demand would be more likely to balance one another out. On the demand side, people would find substitute products. For example, in an oil shortage consumers might use more fuel-efficient cars or alternative fuels, which would result in reduced demand for oil. Meanwhile, on the supply side, companies would produce more oil as prices rose, trying to reap the benefits of increased profits. For example, the oil companies in a shortage situation would respond to higher prices by working harder to produce oil, which would result in an increased supply of gasoline. Eventually supply and demand would probably approach equilibrium.

Recent Trends

The most notable economic shortages in recent U.S. history occurred during the 1970s. The first of these took place in 1973, when oil-producing Arab nations cut off the supply of oil to the United States in response to American support of Israel (which was at war with Syria, Egypt, and other Arab countries). The reduced supply of oil led to skyrocketing gasoline prices in the United States, and President Richard Nixon (in office 1969–74) tried to halt the increases by instituting price ceilings. Economists generally believe that this exacerbated the shortage. Had oil prices been allowed to rise as high as the market dictated, people would have been forced to curtail their gasoline consumption until this restricted amount of demand matched the supply shortage. Likewise, the higher prices rose, the more likely oil companies would have been to supply more gas, thus alleviating the shortage.

In 1979 a crisis in the Middle East again caused an economic shortage. The U.S. oil supply was interrupted by a revolution in Iran that led to the takeover of the country by the religious leader Ayatollah Ruhollah Khomeini (1900–89). The shortage of oil resulted in increasing gas prices and an attempt by the U.S. government to control them through a price ceiling. Again, the price ceiling is believed to have worsened the gasoline shortage.

Since the two oil crises in the 1970s, the U.S. government has generally refrained from using ceilings to control prices that are rising too quickly. Instead, the government’s central bank, the Federal Reserve System (often called the Fed), limits the growth of the money supply (the amount of money in circulation) to stop the rise in prices. In general, the less money there is in circulation, the less demand there will be for goods and services, because people have less to spend. Therefore, by cutting back the money supply, the Fed reduces demand, prompting prices to fall. This technique for controlling prices is generally believed to be a better way to manage the economy than the adoption of price controls, which lead to imbalances between supply and demand.