What it means
Normally, a price adjusts until the amount people want to buy equals the amount available. Rationing steps in when the price is not allowed or not able to do that job.
The scarce item is then shared by some other rule, such as first come first served, proportional shares, or priority to certain customers. Credit rationing is the case finance people meet most.
A bank may have more loan requests than it wants to fund, but rather than raising rates until demand falls, it declines some applicants or gives them smaller loans. Higher rates could attract riskier borrowers and raise the number of defaults, so lenders often prefer to limit quantity.
Inside a company, capital rationing happens when the budget is smaller than the total of all worthwhile projects. Management must rank the projects, for example by profitability index, and fund only the best ones until the money runs out.
Some good projects are then turned down, not because they are bad, but because there is not enough money for all of them. Supply rationing happens in operations when a shortage of materials or capacity forces a business to decide who gets what.
A manufacturer may give priority to its largest customers, or share limited stock in proportion to past orders. The rule used should be clear and fair, as customers will notice and may react.
The nuance is that rationing hides the true price of scarcity. When demand exceeds supply but the price is fixed, queues, waiting lists and shortages emerge, and informal markets can appear.
Spotting rationing is often a sign that prices or interest rates are not reflecting real conditions. Rationing can also be a deliberate pricing choice.
Some firms keep prices below the market level to build goodwill, then ration supply by waiting lists or purchase limits. This keeps customers loyal but gives up revenue that a higher price would have earned, so managers should know what the choice costs.
In practice
Real-world examples.
Example
A small-business lender receives twice as many loan applications as it can fund. Instead of raising its rates, it approves only the strongest applicants and reduces loan sizes for the rest. Some good borrowers are turned away.
Example
A corporate finance committee has $10,000,000 to invest and five projects that each look profitable but total $18,000,000. It ranks them by profitability index and funds the top three. The remaining two wait until next year's budget.
Example
A component maker suffers a supplier shortage and can fulfil only 70% of orders. It allocates stock in proportion to each customer's past orders, so every buyer receives 70% of its usual amount. Key customers are told early so they can plan their own production.
Formula
Calculation
Allocation under proportional rationing = (customer's request / total requests) x available supply
Fill rate = available supply / total requests
A bank has $6,000,000 available for loans in a month, and three business customers request $5,000,000, $3,000,000 and $2,000,000, a total of $10,000,000. The fill rate is 6,000,000 / 10,000,000 = 60%. The customers receive 0.60 x 5,000,000 = $3,000,000, 0.60 x 3,000,000 = $1,800,000 and 0.60 x 2,000,000 = $1,200,000, which add up to $6,000,000.Case study
Seen in the real world.
Alderbrook Components is an illustrative, fictional electronics maker that was hit by a shortage of a key chip. Its customers wanted 100,000 units a month but the company could obtain only 60,000.
The sales team at first filled orders on a first come first served basis, which angered several large customers who arrived late. The finance director proposed proportional rationing so that every customer received 60% of its request, and the largest accounts were also offered a premium option to pay more for extra supply.
Complaints dropped, and the premium option brought in $240,000 of extra revenue during the shortage. The illustrative lesson is that when scarcity cannot be solved by price alone, a clear and fair allocation rule protects relationships.
Watch out
Common mistakes.
- Assuming a lender will raise interest rates indefinitely to meet demand, when it may instead ration credit.
- Treating capital rationing as a sign that projects are bad, when it only reflects a limited budget.
- Using an unclear allocation rule that customers see as unfair, damaging trust.
Questions
People also ask.
Why do lenders ration credit instead of raising rates?
Higher rates can attract riskier borrowers and raise defaults, so lenders often prefer to cap the quantity they lend.
What is capital rationing?
It is a situation in which a company has more profitable projects than money, so it must pick the best and leave some worthwhile ones unfunded.
Is rationing always imposed by government?
No, businesses and banks ration all the time, and government rationing is only one example.
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