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March 2016 Brief: Volume 23, Number 7

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Markets Work Better Than Bureaucrats to Allocate Scarce Resources

 

by Gus Hurwitz

 

 

Snowmageddalypse 2016. It is here, looming over the East Coast. So let’s talk about markets and auctions.

 

I fly a lot. In the past 24 months, I have been stranded at airports at least a dozen times because of severe weather. I have previously slept at DCA, DEN, EWR, FSD, and ORD — and those are just the US airports.

 

Even worse, however, is that in most of these cases I did not need to fly. I could have changed my plans, delayed or canceled a trip, or waited an extra day. And if I had, someone else who had greater need to get to his destination may have been able to do so.

 

Once Snowmageddalypse 2016 hits the East Coast, much of the domestic airline industry, and many airports on the East Coast, will be shut down. Hundreds — possibly thousands — of flights will be canceled or delayed, and these effects will ripple throughout the United States.

 

Moving into next week, passengers stranded or delayed will flood the market as airlines try to get them to their final destinations. Service counters at airports will be swamped. Frustrated customers will be looking for that one elusive seat on some flight that will move them closer to home. There has got to be a better way. And there is. It’s called the price signal.

 

The basic economic problem created by a storm is a sudden, dramatic decrease in the supply of flights. The airlines sold more contracts of carriage than the system is now able to accommodate because of an exogenous shock — they made thousands more promises to get flyers from point A to point B than are now possible. This increases the equilibrium price for each flight.

 

In a perfect world where all parties had perfect information and were able to negotiate, it is obvious (at least to an economist) what would happen: Those who more highly value having one of the few remaining seats would strike deals with those who had contracted with the airlines for carriage. If I were willing to delay or cancel my trip in exchange for $500, and someone wanted to pay me $500 for my seat, I would happily make that deal. I would be happier. The individual buying my seat would be happier. And the airlines would have two fewer frustrated customers, so they would be happier — and this would free up resources to better help other customers. It’s a win-win-win-win!

 

Compare this to what actually happens. The airlines attempt to honor their contracts of carriage. That is honorable and noble, and also what is required by law. If you have a ticket to get from point A to point B, the airlines will get you from point A to point B . . . eventually. And they accomplish it as best they can. Unfortunately, “as best they can” does not mean “very well.” To the contrary, individuals are accommodated largely on an ad-hoc, first-come-first-serve basis, with some additional structure based on frequent flyer status and ticket class.

 

What airlines really need when a storm hits is for folks to stay home — for folks to decide not to fly. Remember the basic economic problem: Severe weather leads to a decrease in supply. One day’s worth of cancellations creates days of backlog. The only way to accommodate this in the short run is an offsetting decrease in quantity demanded.

 

But what else are airlines going to do? They have no way to know if a traveler is a doctor on his way to perform a life-saving surgery or just a businessman on his way to a weekly meeting. Ironically, the high-status frequent flyer would probably be less affected by a delay than the one-off traveler, so it probably would make more sense — and make more people less unhappy — to accommodate travelers in the opposite order of what airlines actually do.

 

So, the basic challenge is how to convince folks voluntarily, willingly, even happily to change their plans.

 

Here is what airlines could — indeed, I would say, should — do. They should create a secondary market in tickets. When a storm hits, or is expected to hit, the airlines should step up to the auctioneer’s podium and embrace the role of market maker. On one side of the market, airlines should allow flyers to sell back seats in exchange for either canceling or delaying their travel. And on the other side, airlines should resell these seats to those with greater needs to keep their travel plans. The airlines would use the revenue raised reselling these seats to pay the customers selling their seats — and the airlines could even take a cut for themselves!

 

That is the power of markets. Markets collect and compile information and put that information to valuable use, and they do so more efficiently than any centralized actor could. Indeed, they do so almost magically, driven as if by each participant’s individual desire to do best for himself. Amazingly, this lets individuals put resources they control to better use. Individuals often do best for themselves by doing good for others.

 

In the case of the airlines, neither airlines nor their customers have a good way to determine who has the greatest need for the few available seats when a storm hits. The airline has no way to tell which passenger is the doctor on a vital trip, as opposed to a business traveler on a junket — and the business traveler has no way to know if his taking a flight is keeping a doctor from a patient.

 

But if we open seats up on a market, the market will gather all this information and reduce it to a single, simple number: the price. That price will let some travelers sell their seats to those who need them more, making both happier. And the number of passengers the airlines need to accommodate with a reduced supply of flights will decrease, thereby benefiting the airlines and all passengers. It’s a win-win-win-win.

 

Justin (Gus) Hurwitz is an assistant professor at the University of Nebraska College of Law. This article was composed while he was on a plane headed to Washington, D.C., during the latest snowstorm. It is reprinted with the permission of the author and first was published as “Airlines, markets, and Snowmageddalypse 2016” by American Enterprise Institute’s Ideas on January 21, 2016.

 

Permission to reprint or copy in whole or part is granted, provided a version of this credit line is used:"Reprinted by permission from INSTITUTE BRIEF, a publication of Public Interest Institute." The views expressed in this publication are those of the author and not necessarily those of Public Interest Institute. They are brought to you in the interest of a better-informed citizenry.

   

 

 

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