The invisible hand in times of crisis

Mads Nordmo Arnestad

Our moral intuition does not agree with the basic tenets of capitalism.

Prices change when the relation between supply and demand changes. This is what Adam Smith referred to as the invisible hand. Most of us learned about this in High School. Many support this mechanism which has lifted billions of people out of poverty created vast amounts of wealth.

When crisis hits we turn out to be more ambivalent to it than we thought. Some use the COVID-19 crisis to increase their profit, and the price of disinfectant and facemasks has skyrocketed. Some shops sell them at nearly five times the pre-crisis prices.

In the US, politicians criticize retailers. Florida has even gone to the extent of establishing a hotline where people can report price increases for COVID-19 related products. It is striking to say the least that the US has a public hotline for reporting price increases as a consequence of increased demand.

The situation in Norway is the same. The number of disinfectant advertisements on the online marketplace Finn.no has increased greatly as a result of increased demand. Opportunistic behavior does not stop there, a Sushi restaurant sells disinfectant at a price of NOK 300 per bottle. That is NOK 1200 per litre, more expensive than their most premium Champagne.

The public despises this type of opportunism, yet there is no comparable loathing of so-called ‘dynamic pricing’: The price of plane tickets varies according to supply and demand without causing much anger, and the price of gold has exploded as the markets have collapsed without anyone decrying this as immoral. It seems we tolerate the invisible hand where we are used to seeing it.

Some new business models have introduced dynamic pricing where we previously were used to manually fixed prices. Uber calculates their prices depending on current supply and demand. When terror struck Sydney, Uber prices quadrupled because of demand. Following this, Uber had to apologize and promise that in such situations they would stop adapting price to supply and demand.

When prices cannot be adapted, it gives rise to surpluses and shortages. An example is the stockpiling of toilet paper and canned goods in the current crisis. The public expects supply to fail and overbuy. The liberal market response to stockpiling would be to allow prices of canned goods and toilet paper to shoot up, thereby causing people to buy less. Yet even proponents of the free market can understand that this does not feel right. In such a situation the wealthy could afford to wipe as much as they wanted, while the poor would have to settle for yesterday’s newspaper.

At the same time we understand that if prices were allowed to adapt, the market would increase supply for goods in high demand. In such a situation napkin producers could start making toilet paper, and moonshiners could start making disinfectant. The invisible hand can make supply and demand meet, but only if prices are allowed to form freely and independently. This is what we refuse to accept when crisis hits, especially for goods that normally have stable prices.

Companies are set up to make money. At the same time, consumers can boycott them if they behave unfairly. In 1986, Kahneman, knetsch and Thaler found that people will accept higher prices if the survival of a company is under threat. We also accept that companies maintain prices despite reduced costs. But if a company increases prices as a result of increased demand we get angry.

People do not think about prices in the way that economic theory suggests. Our moral intuitions are not adapted to the basic tenets of capitalism. We consider the price an implicit contract between consumer and producer, and we do not accept renegotiations in the middle of a crisis.

This text is translated and adapted from an article originally published in DN March 24 2020.

Published 27. March 2020

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