Imagine that there is a huge shortage of oil, and as a result, the price of oil has skyrocketed. Only the upper class of society can afford to buy oil, leaving many people unable to commute to work. What do you think the government should do in such a case? The government should resort to rationing.
Rationing refers to government policies implemented in times of crisis that limit the consumption of critical resources whose supply is affected by the crises. Is rationing always good? What are some pros and cons of rationing? Read on to find out the answers to these questions and much more!
Rationing Definition Economics
Rationing definition in economics refers to government policies that restrict the distribution of limited resources and consumer products according to a predetermined plan. This type of government policy is often implemented during time of crises such as wars, famines, or some other type of national disasters that affect the number of scarce resources that are incremental for the daily life of individuals.
Rationing refers to government policies that restrict the consumption of scarce resources during times of hardship.
It is important to note that the government implements rationing as a policy when resources such as water, oil, and bread are increasingly becoming scarce during time crises such as war.
For example, in times of war, the supply of goods and services may be subject to disputes. This might affect the supply of necessary goods such as water or oil, which might cause some individuals to overconsume or overprice, which enables only some individuals to access it.
To prevent this from happening, the government limits the quantity of oil or water to a specific amount per individual.
Instead of allowing prices to grow to more market-driven levels, governments may limit goods such as food, fuel, and other necessities during conflict and other emergencies.
In times of severe drought, it is common practice to implement rationing policies for water supplies. In the context of the United States, water restrictions for domestic usage as well as water use for agricultural production have often been an issue in the state of California.
Non-price rationing, which involves limiting the amount of the quantity of a good one can consume, is arguably a better alternative than leaving it up to demand and supply forces to determine the market price and quantity during severe crises that impact scarce resources. That's because it provides an equal distribution of resources.
When there is a free market, those with higher incomes can outbid others with lesser incomes to purchase commodities that are in limited supply. On the other hand, if goods are rationed, which enables everyone to consume only a certain amount, everyone can consume such resources.
- It is important to note that a rationing alternative is considered to be better only in times of crises, such as war or drought. It is designed to ensure everyone has access to essential resources.
- Rationing, however, is not considered to be a good alternative in a free-market economy under normal times. This is because the government affecting demand and supply can cause an inefficient allocation of resources.
Rationing Examples
There are many rationing examples. Many crises have pushed governments to resort to rationing to combat these crises.
The United States supply of essential commodities such as food, shoes, metal, paper, and rubber was severely strained by the demands of World War II.
Both the Army and the Navy were expanding, and so was the nation's attempt to support its allies in other countries.
Civilians still required these goods for the production of consumer items.
To keep up with this ever-increasing demand, the federal government instituted a rationing system that affected almost all households in the United States. This was one of the measures to save vital resources and ensure their continued availability.
As a result, during World War II, the US government rationed sugar, coffee, meat, and gasoline.
Another example of rationing could be happening soon, as European politicians are discussing gas rationing because of the 2022 Russia-Ukraine conflict and geopolitical concerns. Europe is experiencing natural gas shortages due to its heavy reliance on Russia's natural gas.
European leaders are urging households and companies to ration gas and electricity voluntarily. While the governments have taken various steps to try to avert this problem, many experts think mandatory rationing would be needed in winter.
Effects of Rationing in Economics
To understand the effects of rationing in economics, let's assume that the economy is going through a severe oil crisis. The oil supply is plummeting, and the government decides to ration the amount of gasoline an individual can consume.
Let's consider the case of Mike, who makes $30,000 a year from his monthly income. Let's assume that Mike has a certain amount of gasoline he can buy in a given year. The government decides that the amount of gasoline an individual can buy is equal to 2500 gallons per year. In other circumstances, where there was no rationing, Mike would have been happy consuming 5,500 gallons of gasoline per year.
The price of gasoline set by the government is equal to 1$ per gallon.
When the government rations the amount of quantity consumed per person, it is also capable of influencing the price. That's because it suppresses the demand to levels that keep the price at the desired rate.
Fig. 1 - Effects of Rationing
Figure 1 shows the effects of rationing on consumers such as Mike. Mike's yearly fuel consumption is shown along the horizontal axis, and the amount of money he has left over after paying for gasoline is shown along the vertical axis.
Because his salary is $30,000, he is restricted to the points on the budget line AB.
At point A, we have Mike's total income of $30,000 for the year. If Mike refrained from buying gasoline, he would have $30,000 in his budget for purchasing other items. At point B, Mike would spend his whole paycheck on fuel.
For one dollar a gallon, Mike could buy 5,500 gallons of gasoline per year and spend the remaining $24,500 on other things, represented by point 1. Point 1 also represent the point where Mike maximizes his utility.
If you want to learn more about utility, check out our article - Utility Functions.And if you need more support to understand the graph above, check out:- Indifference Curve
- The budget constraint- Budget constraint and its graph.
However, as the government rationed the amount of gallons Mike could buy in a year, Mike's utility dropped to lower levels, from U1 to U2. At the lower utility level, Mike spends $2,500 of his income on gasoline and uses the remaining $27,500 for other items.
- When rationing occurs, individuals can't maximize their utility because they can't consume the number of goods they otherwise would have preferred.
Types of Rationing in Economics
The government can pursue two main types of rationing in economics to tackle crises:
non-price rationing and price rationing.
Non-price rationing occurs when the government limits the amount of quantity that an individual can consume.
For example, in times of crises that influence the gas supply in a country, the government can reduce the number of gallons an individual can consume.
Non-price rationing allows individuals to access a commodity they otherwise would not be able to purchase since it ensures that every eligible person will get a minimum quantity of gasoline.
In addition to non-price rationing, there is also price-rationing, also known as a price ceiling, that the government may decide to implement as a policy.
Price ceiling is the maximum price a good can be sold for, which is permitted by law. Any price above the price ceiling is considered to be illegal.
Price ceilings were used in New York City after World War II. As a direct result of the end of World War II, there was a severe scarcity of housing, which led to soaring rent prices for apartments. At the same time, soldiers were returning home in large numbers and starting families.
Let's consider the effects of the price ceiling on rent. If rent was set at a certain amount, let's assume $500 per one-bedroom apartment, while the equilibrium price of renting the room in New York City is $700, the price ceiling would cause a shortage in the market.
Fig. 2 - Price ceiling below equilibrium
Figure 2 shows the effects of the price ceiling on the real estate market. As you can see, at $500, the demand is way higher than the supply, which causes a shortage in the market. That's because the price ceiling is below the equilibrium price.
Only a certain amount of people can rent houses using a price ceiling, which is represented by Qs. That would typically involve individuals who have managed to get hold of rent first or individuals who had acquaintances that rented houses. This, however, leaves many other people (Qd-Qs) without the ability to rent a house.
While a price ceiling could be beneficial as a type of rationing because it ensures that prices are affordable, it leaves many individuals without access to necessary goods.
Problems with Rationing in Economics
Although rationing can be beneficial during a crisis, there are some problems with rationing in economics. The main idea behind rationing is to limit the number of goods and services one can receive. The government decides this and the right amount of rationing is not always chosen. Some individuals may need more or less compared to the amount that the government decides to provide.
Another problem with rationing in economics is its effectiveness. Rationing does not permanently eliminate the effects of the laws of supply and demand on the market. When rationing is in place, it's common for underground marketplaces to emerge. These allow individuals to exchange rationed items for ones that better suit their needs. Black markets undermine rationing and price restrictions because they enable individuals to sell products and services at prices that are more in line with demand or even higher.
Rationing - Key takeaways
- Rationing refers to government policies that restrict the consumption of scarce resources during times of hardship.
- When rationing occurs, individuals can't maximize their utility because they can't consume the number of goods they otherwise would have preferred.
- The government can pursue two main types of rationing to tackle crises, non-price rationing and price rationing.
- Non-price rationing occurs when the government limits the amount of quantity that an individual can consume.Price ceiling is the maximum price a good can be sold for, which is permitted by law.
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