In Defense of Price Gouging

Many of you probably saw this on Monday, but for those who didn't: Writing in the Boston Globe Jeff Jacoby patiently explains supply and demand to folks who wring their hands about "gouging" whenever, shockingly, prices rise in response to some unusual event (say, a hurricane) suddenly and dramatically increasing demand for certain goods.

Comments

[grylliade]

Why not face up to the converse: a very wealthy spoilt individual with money to burn, against an Average Joe desperately trying to get home to a sick child?
And in commercial terms, think of the loss of good-will among potential curtomers.

It's not a perfect system to allow prices to find their own equilibrium after a disaster, but it's better than any other. You can't really argue just from poking holes in a free market solution; you have to present a viable alternative that finds a better balance between costs and benefits. There are going to be problems with allowing so-called "price-gouging"; the problems with any other system will be much, much worse.

The "eventually" is the problem here. In the aftermath of a disaster, the demand goes up for several different reasons, one of which is that the distribution of certain goods and services suddenly becomes a life or death issue. If, for example, the water and wastewater systems are destroyed, people without water filters have a choice of 1) not drinking water or 2) getting water from contaminated water bodies. If profiteers price large numbers of people out of the market, yes, within a couple of weeks, more filters will be delivered and the price will come down. But two weeks is plenty of time to get sick from fecal-infected drinking supplies.

Well, joe, if you artificially lower the price of water filters to avoid "price-gouging," then you sell out of the filters very quickly. If you only have five hundred filters on hand in a community of a thousand households, you'll either sell cheaply to the first five hundred people to come through your door, or expensively to five hundred people who are willing to pay through the nose for a water filter. Either way, only five hundred households get a water filter. The other five hundred are going to have to do without, no matter what the price of the water filter was. If the filter is expensive, it's more likely that, say, two households will go in on the price of a filter, and can share it until more filters and/or clean water arrive.

In no way are you actually better off with no "price gouging"; you just don't have people complaining about "price gouging." Meanwhile, you have five hundred households with no clean drinking water, and less incentive to get more water filters in from outside, since they're only going to get the regular price for it. If you allow the price to rise to reflect the limited supply, the water filter manufacturers are more likely to ship to the disaster area, since they'll get more profit from doing so. And it'll be a damn sight faster than if you didn't allow "price gouging." Or you could have the government handle it, which will probably take longer than letting the market take care of it (since God knows that we have to make sure all the paperwork is filled out, etc.), and will definitely cost more. *shrugs* Your call.

If we are to accept the premise of Jacoby's argument, people demonstrating such compassion are harming their neighbors by undermining the system of price spikes that is supposed to be their salvation. You can't have it both ways - either selling goods for less than the disaster-induced price is good, or it is harmful.

It might be harmful, but it's certainly allowable. See above comments on imperfections of market systems as opposed to imperfections of other systems.

[julep]

For a slightly longer version of essentially the same article see: http://www.mises.org/fullstory.aspx?control=1593.

Joe, I don't think anyone is trying to have it both ways. The folks who've posted in favor of raising prices of scarce goods--be they ice, generators, or dialysis--are expressing an opinion that the market--not the gov't--should decide the price of a good. If there's any competition at all, some vendors are going to be compassionate, while others are going to be greedy bastards. The compassionate vendors will gain the appreciation and respect of their customers (i.e., they will shop there again in the future); the greedy bastard vendors will maybe make the one sale, but at the cost of repeat business (i.e., they will lose customers). If there's no competition, it will hurt in the short term, but you can be sure that some entrepreneur will open up a competing business nearby soon and/or folks will learn to be more prepared next time (a la "touch the toaster" above).

No one is forcing consumers to buy an overpriced good, so even if they don't have their choice of vendors they do have a choice to buy or not.

[Shannon Love]

joe,

I think you're to caught up in theory. The nuts and bolts of the problem is this: following a disaster their is a shortage of needed goods. There is not enough for everybody so somebody is not going to get something they need. The goods must be rationed. The question is what is the best system that gets the most necessary goods to the people that need the goods most?

We have two possible systems for doing this, a market driven system were people communicate need by the prices they pay and a randomized first-come-first-served (FCFS) system were people get goods based on their physical proximity to the goods. In either system, somebody goes without.

In either system a plea to compassion can work for exceptional cases. One disadvantage of the FCFS system is that people have no incentive to self-ration. Stockpiles get hoovered out nearly immediately. These means nothing is left for exceptional cases that show up late.

All this is academic. The real reason we don't let market forces operate is political. People would rather risk going without and let others benefit at random than to know that some got more than others because of their superior wealth.

I think this another cases where our seemingly inherent conception of fairness that evolved when humans lived in small intimate communities causes killing inefficiencies when applied to large scale complex systems like a modern economy.

[mtc]

Thank god, I was waiting for someone to say it. The 5.00$ a gallon at some gas stations after 9/11 was gouging, playing entirely off of people's panic and irrationality. I'm sure there's an element of it in florida, but this round of griping is just another example of people saying stupid things for lack of having ever taken econ 101.

I can see a place like florida enacting some sort of law that would freeze prices for a few weeks everytime it looked like a hurricane was gonna hit. Wonder how loud the complaining would be when ice, generators, and other useful things in a disaster area were not expensive, but completely unavaible. Then of course they'd probably be demanding it all directly and free from the Feds, which brings me to my next point...

I can easily support giving people food, water and shelter immidiately after a disaster ao that they're alive and safe, but I can't see why we should all have to shoulder the cost of rebuilding in disaster prone areas via federal disaster relief. Reason's covered this pretty well, but it's not just that such money marked for rebuilding is shameless pork as with Bush I and hurricane Andrew. Here in connecticut we haven't seen a comparable storm since 1933, I beleive, and since only a few blizzards and one F4/5 tornado (which I only bring up because I'm a weather geek and it touched down 25 years ago more or less where I'm sitting). We all pay in for it, but unless your in the midwest getting flooded or twisted, california getting earthquaked, or in the southeast getting hit by hurricane, natural disasters meriting billions of dollars of federal aid are probably a once every fifty or hundred years event.

Well that's just so much pissing into the wind about a relatively minor problem about what the federal government does with our money.

[Adam]

I expect for prices to rise after a disaster, it's fundamental free market economics after all. However, I am sympathetic to the victims when they see an order of magnitude or higher increase in price. I have heard about some folks paying over ten times the normal rate for essential services like tree removal. This certainly smells to me like gouging and I have at least moral objections to it. Having said that, I agree with another poster who pointed out that said vendors may not get repeat business and are probably cutting their own throats. I imagine that I wouldn't be real happy having to pay thousands of dollars for a service that normally costs lets say $200.

The thing that really pisses me off, though, is the government continually forking out for those idiots who continually build dwellings in extreme disaster risk areas. That and people who aren't smart enough to take adequate precautions when there is warning of a looming event.

[Dan]

The inevitable result of 'anti-price gouging' laws is government rationing. Because otherwise there will be a run on goods, and they'll be allocated not by need, by by first-come, first-served. The guy who already has a water filter but wants another one 'just in case' gets one just because he was a little quicker on the draw than the orphanage with tainted water.

This is not supposition. If the demand rises and the price stays fixed, you WILL have shortages, and very quickly. There's no way around it. Then people who really, really need the goods can't get them at any price.

Another problem with anti-gouging laws is that you get an immediate rise in the black-market. If I can buy water filters for $1.00 when the demand price is $20, there's nothing stopping me from buying up a store's entire inventory and then selling out the back of my truck for a 500% profit.

So there's the result of your compassion: Shortages, misallocated resources, criminal activity. Yay team. Good work.

Inevitably, these bad results then create a call for government rationing. Now you get to have national guardsmen taking over inventories and allocating them based on what some technocrat with imperfect information thinks is a right. And this is an improvement?

By definition, bad stuff happens when disasters hit. "Price gouging" may be distasteful, but you just don't have the luxury of doing away with it because it offends your sensibilities. All the alternatives are far worse.

[KentInDC]

Adam,
Why would someone pay ten times the non-disaster price to have trees removed? Maybe for the same reason the butcher was willing to pay more for the generator - he is going to sustain more damage than the cost of the relief if he doesn't. Again, those with the most to lose sort themselves out via the price mechanism. In addition, the promise of making big bucks brings more people with tree removal equipment and expertise (and unfortunately, some who only claim such expertise) into the disaster area.

[joesux]

You're wasting your keystrokes, Dan. joe doesn't understand economics. He's got selective compassion down pat. Not too shabby at employing fallacious arguments, either.

[joe]

It's rare that I get accused of being too caught up in economic models, and of not knowing economic models, in the same thread.

grillyade, good response. It's rare to see someone admit imperfections in their preferred position. The insistence that there CAN'T be a downside to completely unregulated markets is how people starving in the streets gets justified as "social Darwinism," and how Ayn Rand ends up saying it's evil to help those in need just because you want to.

Florida's anti-gouging laws mandate that the price stay exactly the same as before the disaster. This is clearly a hardship for suppliers, as their cost of doing business (including opportunity costs, as they could have their own cleaning up to do) rise and can't be covered by the normal prices. In Alabama, otoh, the disaster prices have some give, which is fairer to the vendors, and allows for the profit seeking from outsiders that creates the excess supply. But now we've got the problem of, how much higher is too high? Alabama sets a standard % across the board, but this would seem to assume that the cost of doing business rises the same amount for all goods and services, which clearly isn't correct. So now we're talking about a system in which the people with the best knowledge of how disasters affect their little corner of the economy decide on a maximum price increase during emergency periods, with the government enforcing the decision. An imperfect solution, yes, but hey, they're all imperfect.

Shannon, not all gouging results from shortage. There was no shortage of gasoline after 9/11, or prior to the first Gulf War, yet providers raised prices just because they could exploit people's fears. People who have just suffered through a disaster are not likely to behave as rationally as they do in normal times, and exploiting irrational fear and pain doesn't bring any economic benefit. Or does it?

But what do I know? I have no conception of economics, and am only interested in making fallacious arguments.

[seeker]

Perhaps I am just slow at this but after reading all of the posts, it was finally joe's last post that made it click for me.

One of the advantages of overly priced goods after a disaster is this: In the Florida case, let's say I was from Alabama and I had a trailer. On a normal day, it wouldn't be worth squat for me to buy 5 generators at Home Depot for $200 and drive down to Florida for the weekend to sell them for $200. If I knew I could sell them for $1000 a piece and was almost guaranteed to sell them before the weekend was out, I'd do it. I'd make great money. There might be 5 people that felt they got gouged, but they got generators they needed and I got the incentive to deliver the goods.

[Eats Shoots Leaves]

hurricaine...anything like novocaine or cocaine..?

[PaulP]

I have read somewhere that just after 9/11 auto hire firms put up prices outrageously at airports (flights were grounded for a few days). I do not see how the defence of gouging offered here is relevant in this case. The higher prices would not attract more autos for hire or new companies into the market. Supply was inelastic (the grounding was never going to last).

[KentInDC]

PaulP,
The higher prices on rental cars ensured that those who most valued the transportation provided by the cars were able to rent them. In addition, it encouraged the sharing of rides (I've shared rides with complete strangers due to problems at airports and other places, and obviously I'm not the only one.) and returning cars to the rental agencies more quickly. I think Professor Boudreaux explained the demand side pretty well in the next to last paragraph about the butcher valuing the generator more than the guy who wants power to watch TV and operate his PC.

[thoreau]

joe-

I freely admit that gouging sucks. Being more of a pragmatist, I wouldn't completely rule out on principle ANY sort of anti-gouging law. But an anti-gouging law would have to avoid throwing out a few babies with the bathwater:

1) Gouging can prevent hording. If a supply goes up in price I'm more likely to only buy enough for survival rather than enough for comfort. That means more households will have the necessities. Without gouging, the first few buyers might stock up on enough to enjoy comfort, leaving the rest out of luck. The result would be more inequity among households, something I suspect you wouldn't be thrilled with. (Although some posters here might be thrilled with it. Who knows? Maybe I'll get joe and some die-hard to swap positions?)

2) I wonder if any studies have been done to see if anti-gouging laws cause the market to take more time to reach equilibrium. As other posters have pointed out, higher prices make it more likely that suppliers outside the affected area will pull out all of the stops to move products into a disaster area.

Of course, some people conclude that with anti-gouging laws there would be NO incentive to move more supplies to disaster areas. This is clearly false, since you can make a profit off of higher volume (e.g. higher demand for bottled water, or filters, or generators, or canned food, etc.) as well as off of higher price. Either way the market provides incentives to move supplies into the disaster area, but gouging provids MORE incentives.

These first 2 points put together make it clear that anti-gouging laws run the risk of making more people miserable for a longer time, while gouging provides a sort of rationing and also brings goods to the market faster.

There's a third point:

3) It's not at all clear that retailers would bother to sell much of anything if gouging were prohibited. Although some supplies will definitely move more quickly in the aftermath of a storm (e.g. bottled water) other supplies won't move at all (e.g. anything needing refrigeration, anything that's a luxury or gift). Whatever extra money a store-owner is making off of higher volume on some goods, he's losing to lower volume on other goods. Without higher prices, the store might not make any extra money.

So what? Well, if a store-owner's family is injured and his house is destroyed, going to work for the normal profit might not seem like a priority, leaving everybody else in the community in worse shape. On the other hand, raking in a bunch of extra money to pay for those house repairs and hospital bills might seem quite nice, making him more likely to sell the things that everybody else needs right now.

So, while I am not a free-market fundamentalist who believes it a sin to regulate prices, I am a pragmatist who worries that anti-gouging laws will throw the baby out with the bathwater and make most people worse off while benefiting a lucky handful.

[patrick]

There's is also the question of what expectations the "gougers" have. I mean, take Joe's example of gas prices after 9/11. We all know that there would be no shortage in the weeks following the attack, but did we all know that immediately? Clearly not, otherwise the folks wouldn't pay $5/gallon. But if the consumers didn't know, who's to say what the retailers did or didn't know. Prices factor in expectations, and expectations of future shortages would certainly raise prices.

[KipEsquire]

Another aspect of "gouge is good" that people often overlook is what I call the "touch the toaster" argument.

You can tell your child not to touch the toaster, that it's hot and he'll get burned and it will hurt. But in the end, often the only way he'll learn is to actually let him go ahead and touch it. Ouch. But the burn eventually heals and the lesson is learned.

Likewise, if you're reckless in your emergency planning and end up getting gouged once: ouch! But you likely won't make the same mistake the next time.

[Dan]

Of course, some people conclude that with anti-gouging laws there would be NO incentive to move more supplies to disaster areas. This is clearly false, since you can make a profit off of higher volume

It is only "clearly false" for goods that can be produced very quickly and have a high enough profit margin to overcome the increased distribution costs brought on by the disaster.

In a stable market, producers will only produce slightly more than is consumed by customers. When demand jumps sharply, producers must either (a) alter their distribution scheme, leaving some of their normal buyers without product or (b) produce more of the product.

A disaster causes only a short-term increase in demand -- too short for many goods, such as gas-powered generators, to be assembled and distributed. So, for many products, option (b) is not a possible means of reacting to a disaster. That leaves (a).

Well, what's the incentive for using option (a) at all? Let's say you sell 100 widgets in a typical week -- 50 to New York and 50 to Miami. Miami gets hit by a hurricane, screwing up the roads and increasing widget demand to 600, but "anti-gouging" laws prevent an increase in the sale price of widgets. What do you do? Answer: you sell 50 widgets to New York, and the same 50 to Miami. You have NO reason to send more widgets to Miami and fewer to New York, because you make less on a Miami sale than a New York one.

Now, if you think widget demand will stay high in Miami for, say, a month, and you can get new widgets produced in a week -- then, sure, you produce more widgets and ship them to Miami. A week late. And you don't ship too many of them, because you know your widget rivals will also be stepping up production, and since your profit per unit is still low you won't want to risk getting stuck with unsold widgets.

[Shannon Love]

One benefit of disaster pricing is that it will encourage distributors and retailers to stockpile resource in the immediate area in anticipation of emergency. When a major disaster strikes transportation often breaks down. Goods can't reach the affected area regardless of the price. The area must rely on it's local stockpiles. Maintaining stockpiles is expensive, however, and the business maintaining the stockpile can never really know if it will be used or not. If the disaster does not occur (the hurricane zigs instead of zags) the the business eats the loss on the stockpile. Disaster pricing would give them an incentive to stock-up before hand.

Of course, stockpiling beforehand would also reduce the price following the disaster. Like many economic issues, it's a feedback loop.

[PaulP]

KentInDC:

"At the same time, price increases perform what George Mason University economist Donald Boudreaux calls "economic triage," directing supplies and repairs to those whose need for them is most pressing. Someone who wants a generator so he can power his computer and TV might be willing to rent one for $250. At $400, he is more likely to decide he can live without it -- thereby making it available to the butcher desperate for electricity so he can keep thousands of dollars' worth of meat from spoiling.

When demand increases, prices go up. As prices rise, supplies do, too. And with higher supplies eventually come lower prices"

The second paragraph makes part of my point: in the case of auto hire after 9/11, this paragraph was not operative because new autos for hire would not become available in the short time of the grounding of flights.

The first paragraph assumes that in general the ability to pay for a good and need for a good go hand-in-hand . At $300 per day for a typical auto hire, obviously those with lots of money but little need will get their vehicle, while those with little money but great need will be stranded. It's very interesting that this argument contrasts a butcher with a need (and ability to pay) to an apparently casual PC user. Our sympathy is obviously with the unfortunate butcher who is trying to keep his business going. Why not face up to the converse: a very wealthy spoilt individual with money to burn, against an Average Joe desperately trying to get home to a sick child?
And in commercial terms, think of the loss of good-will among potential curtomers.

[Baylen]

I have a bet going that there is a disaster-specific term for price-gouging, which obviously doesn't just happen during disasters. Any idea if I'm right or wrong? I seem to remember hearing the term when I lived in Florida. Just wondering.

[Evan Williams]

Shannon,

That model only works for predictable disasters and nonperishable goods/services. No one could have predicted 9/11 like they predict hurricanes. Tornadoes and earthquakes are also less predictable.

Personally, I like the "touch the toaster" idea alot. Too bad it doesn't work, though, because the idiot government steps in and bails all the helpless fools out of their mess.

"Duhhh, hey honey, let's buy us a trailer, then set up camp in the path of recurrent hurricane destruction!"

"But, Jimmy, ain't that dang-r-us? I mean, what happens when the good lord ups and takes our trailer and smashes it to pieces?"

"Oh, sweet li'l naive Brandeen. What ya don't understand is that, no matter how little insurance we got, no matter how horrible a state of disrepair our house is in, no matter how stupid we be, Uncle Sam will always be there to bail us out. So, no need to worry. We kin be as stupid as we wanna be!"

[Evan Williams]

Shannon,

That model only works for predictable disasters and nonperishable goods/services. No one could have predicted 9/11 like they predict hurricanes. Tornadoes and earthquakes are also less predictable.

Personally, I like the "touch the toaster" idea alot. Too bad it doesn't work, though, because the idiot government steps in and bails all the helpless fools out of their mess.

"Duhhh, hey honey, let's buy us a trailer, then set up camp in the path of recurrent hurricane destruction!"

"But, Jimmy, ain't that dang-r-us? I mean, what happens when the good lord ups and takes our trailer and smashes it to pieces?"

"Oh, sweet li'l naive Brandeen. What ya don't understand is that, no matter how little insurance we got, no matter how horrible a state of disrepair our house is in, no matter how stupid we be, Uncle Sam will always be there to bail us out. So, no need to worry. We kin be as stupid as we wanna be!"

[Evan Williams]

Shannon,

That model only works for predictable disasters and nonperishable goods/services. No one could have predicted 9/11 like they predict hurricanes. Tornadoes and earthquakes are also less predictable.

Personally, I like the "touch the toaster" idea alot. Too bad it doesn't work, though, because the idiot government steps in and bails all the helpless fools out of their mess.

"Duhhh, hey honey, let's buy us a trailer, then set up camp in the path of recurrent hurricane destruction!"

"But, Jimmy, ain't that dang-r-us? I mean, what happens when the good lord ups and takes our trailer and smashes it to pieces?"

"Oh, sweet li'l naive Brandeen. What ya don't understand is that, no matter how little insurance we got, no matter how horrible a state of disrepair our house is in, no matter how stupid we be, Uncle Sam will always be there to bail us out. So, no need to worry. We kin be as stupid as we wanna be!"

[Evan Williams]

Shannon,

That model only works for predictable disasters and nonperishable goods/services. No one could have predicted 9/11 like they predict hurricanes. Tornadoes and earthquakes are also less predictable.

Personally, I like the "touch the toaster" idea alot. Too bad it doesn't work, though, because the idiot government steps in and bails all the helpless fools out of their mess.

"Duhhh, hey honey, let's buy us a trailer, then set up camp in the path of recurrent hurricane destruction!"

"But, Jimmy, ain't that dang-r-us? I mean, what happens when the good lord ups and takes our trailer and smashes it to pieces?"

"Oh, sweet li'l naive Brandeen. What ya don't understand is that, no matter how little insurance we got, no matter how horrible a state of disrepair our house is in, no matter how stupid we be, Uncle Sam will always be there to bail us out. So, no need to worry. We kin be as stupid as we wanna be!"

[Shannon Love]

PaulP,

You need to understand that we are dealing with two separate time frames here: (1) The time before the disaster (2) the crises period immediately after the disaster. The price structure alters economic behavior in both time periods but especially in (1).

Secondly, what real-world practical model exist for the non-economic distribution of goods and services following a disaster? It is easy to say that the person with the sick child should get the car but how exactly would you make the determination of who most needs a resource during time (2)? All the practical mechanism for making such judgments collectively will not be functioning.

The only way of making the determination is by autonomous individuals exercising their judgment and compassion. Letting prices float in no way undermines this. People in a position to benefit economically from the disaster can still override their economic interest in the name of compassion and studies of post disaster behavior suggest in most cases they will.

[Awed Fellow Poster]

Shannon Love,

Gee you're smart!!!

[joe]

"When demand increases, prices go up. As prices rise, supplies do, too. And with higher supplies eventually come lower prices"

The "eventually" is the problem here. In the aftermath of a disaster, the demand goes up for several different reasons, one of which is that the distribution of certain goods and services suddenly becomes a life or death issue. If, for example, the water and wastewater systems are destroyed, people without water filters have a choice of 1) not drinking water or 2) getting water from contaminated water bodies. If profiteers price large numbers of people out of the market, yes, within a couple of weeks, more filters will be delivered and the price will come down. But two weeks is plenty of time to get sick from fecal-infected drinking supplies.

" People in a position to benefit economically from the disaster can still override their economic interest in the name of compassion and studies of post disaster behavior suggest in most cases they will." If we are to accept the premise of Jacoby's argument, people demonstrating such compassion are harming their neighbors by undermining the system of price spikes that is supposed to be their salvation. You can't have it both ways - either selling goods for less than the disaster-induced price is good, or it is harmful.

[joe]

Good 9:35 post, Dan. It is important to remember that the emergency situation, the acceleration in demand, and the return to normal, take place over a much shorter period of time than under normal conditions.

As for your widget example, it only holds true for goods for which there is little or no excess, and which would have to be manufactured special for the disaster. In the case of services, say construction/demolition labor, neither condition is true. I conclude from this that there was no benefit from the guy with the chainsaw charding $10k for each tree removed.

[kevrob]

Gouging doesn't occur in a vacuum, either. No matter if prices are frozen, controlled or allowed to float, the Red Cross, Salvation Army and other private organizations that respond to calls for aid from areas hit by disasters are still going to provide as much as they can to those who can't pay the going rate on either the open or "informal" market. If family X goes to buy bottled water, and the price is a strain for them, they should know to go to the distribution point or shelter the local radio station is continually reminding them about. When Charley hit the Suncoast, church groups up here in Wisconsin were buying up generators (Generac has a factory here) and trucking them down South.

When drought hit here a few years ago, Southern farmers sent freightcars full of hay up North to feed the dairy herd. One reason why was because Midwestern farmers had done the same for them when they had a long spell without rain. Voluntary mutual aid is not just a Kevin Carson fantasy.

Kevin

[thoreau]

Dan-

Good point. In some cases volume alone is not an incentive, as you demonstrated. However, there are some situations where volume alone would be an incentive to send more products to a disaster area, and it's better to acknowledge them and then point out that it's still better to have the double-whammy of volume AND price to encourage people to bring in supplies ASAP. Time is critical in a crisis, and so the more incentives the market brings to bear the faster people will get relief.

If we don't acknowledge that volume alone is sometimes incentive enough, free marketeers open themselves up to being accused of dishonesty, or at least of sloppiness. It's better to acknowledge the point and then turn it around by asking why any compassionate person would want to artificially reduce the incentives to provide more gear to disaster areas.