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Grading John Stossel, Volume 1…

September 7th, 2011 · 5 Comments
Econ 101 · Policy

Yep, you read that right. A few weeks ago, I got an invitation to a taping of John Stossel’s show on the Fox Business Channel:

I think my friend thought I would want to come to the show because there were a number of economists as guests, and he wasn’t wrong. The theme of the show was “defending the indefensible,” which generally translates to “let’s talk about economic transactions that people generally view as icky.” (Harvard Professor Al Roth actually does quite a bit of research on this subject, and he refers to the indefensible as “repugnant transactions.”) So how did the guests do? Let’s watch the first part of the show:

I obviously can’t help but provide some running commentary of my own, in pretty much the same way that I give feedback on my students’ term papers of course, so here goes.

Segment 1 – Child Labor: I love how Boaz starts an argument about why child labor isn’t bad with “look, it’s not like it happens here.” If there was nothing wrong with child labor, wouldn’t that be an irrelevant point? =P That said, he’s kind of right about the “reign of terror” against lemonade stands- there have been several reports recently about kids’ lemonade stands getting shut down for not having the proper permits, which does seem a little silly. (see here and here for examples) I get the “if we let lemonade stands run wild, no one is going to know what is in their lemonade” reasoning, but I would also venture to guess that any non-moron kind of knows what to expect (or not expect) when purchasing a beverage from a group of 10-year-olds on a front lawn.

Continuing on…ohhhhh, I get it now. Boaz isn’t technically saying that child labor is fine, he’s just arguing that other alternatives are worse. This is a principle I can get behind, since there is evidence that banning child labor results in more poverty, prostitution, etc. than it does schools and spelling bees. (Dear American companies: If you actually want to do the “right” thing, perhaps rather than fire your young workers you could build some schools in or near your factories? Just a thought.)

Segment 2 – Price Gouging: What lawmakers call “price gouging,” economists call “normal market response to the forces of supply and demand.” From a legal perspective, price gouging is defined as follows:

Price gouging is often hard to define, and is often described vaguely as charging “unconscionably” high prices. For example, price gouging may be defined as renting, selling or offering to rent or sell a commodity at an “unconscionable price”.

Price gouging statutes seek to stem opportunistic behavior, which is designed to take advantage of an unforeseen opportunity to charge a monopoly price by threatening to withhold output. It is often defined as a 10 to 25 percent increase over prices during the month before an emergency. One state defines “unconscionable price” as an amount charged, which either represents a “gross disparity” or “grossly exceeds” the average price available for these items and services in the same area 30 days immediately before a declaration of a state of emergency.

In general, I really dislike the concept of vague laws. In this instance, I particularly dislike the concept that the price gouging laws are helpful because price gouging is bad for society, since it’s not always true. Let’s investigate:

In a market economy like the one found in the United States, prices are determined by the forces of supply and demand. Specifically, prices end up at the point where the quantity of an item that people want to buy is the same as the quantity of the item that companies want to produce and sell. In other words, the market price is the price where everyone can get the thing they want and there is none left over going to waste. Graphically, a market equilibrium looks like this:

This natural market outcome is efficient in that it maximizes value to consumers and producers collectively. However, this doesn’t mean that value is split “fairly” between consumers and producers or that the market’s product is allocated equitably among consumers. Economists typically focus on efficiency, since it is objective and quantifiable, and leave it to others to think about equity considerations. This is not a huge deal when discussing markets for iPods or televisions, but equity considerations become much more relevant when analyzing markets for items that are considered necessities.

When people decide that they want more of an item, demand increases. If prices didn’t also increase, there wouldn’t be enough of the item to go around and some people would be left with nothing. An increase in price generally causes companies to supply more of the product and fewer consumers to want to buy it, and the combination of these two factors relieves the potential shortage:

Now let’s consider the price-gouging accusation. If we assume that it didn’t get any more expensive for companies to supply their product, they are clearly better off by “price gouging” (I think the quotation marks are appropriate in this scenario) since they sell more product at a higher price. The effect on consumers, however, is less clear. On one hand, some consumers are losing out because they are paying a higher price for an item that they would have been able to purchase anyway. (You can envision these people as the ones at the front of the line for the item.) On the other hand, other consumers are benefiting since they are able to purchase the product that they are willing to pay the market price for, whereas at the lower price they would have been left empty-handed. It’s unclear which of these effects on consumers is larger, so whether “price gouging” helps or hurts consumers depends on individual market dynamics.

From a fairness perspective, the tradeoff could also depend on the demographics of the markets, since making stuff more expensive for poor people so that rich people don’t have to deal with shortages doesn’t exactly make for a compelling ethical argument. Boaz argues that people who are willing and able to pay the most for an item are those with the most need, which isn’t necessarily true in a society with considerable income inequality. For example, the maximum price that Bill Gates would pay for bottled water during a hurricane is probably greater than the price I would pay, but it’s nonsensical to then conclude that he needs the water more.

Furthermore, the conclusion above relies on the assumption that the higher prices actually induce companies to produce and sell more of the item. This may not be true over short periods of time, both due to logistical constraints and the fact that emergency situations often make transportation challenging. (In other words, Boaz’s “if you triple the price, you get triple the generators” claim is mainly speculative.) If companies can’t increase their production volumes, the market looks something like this:

In this case, the higher price doesn’t make it possible for more consumers to get the item, it just transfers value from consumers to producers. In this case, “price gouging” laws appear somewhat more justified, since companies are purely profiting at consumers’ expense and an increase in price wouldn’t increase the value created by the market.

There’s even a third scenario to consider- what if the emergency makes it more expensive to produce and sell the item? This is a reasonable possibility when companies have to figure out how to get product in and operate under adverse weather conditions, etc., and it looks like this:

In this scenario, it seems absurd to disallow companies to raise prices to help cover their increased costs, especially since there would be massive shortages otherwise. As a result, most “price gouging” laws are written to only disallow price increases that are not driven by increases in production and sales costs.

The point that Stossel was trying to make, I think, is that price gouging is not automatically bad. I agree with that point, and I will even go as far as to quote my econ 101 and say that price gouging is economically efficient for producers and consumers collectively. However, by trying to provide a TV-appropriate abridged analysis, his guests seem to have made the generalization that price gouging is automatically good for consumers, which is not true either, as the above analysis shows.

Segment 3 – Ticket Scalping: The analysis here, interestingly enough, is mainly the same as that for price gouging above, since there is a tradeoff between higher prices and a shortage. However, since stadiums and concert venues are of a fixed size (and aren’t the ones benefiting from the higher prices that scalpers create), there is no increase in overall supply as a result of the higher prices, and what we see in resale markets is just a transfer of value from consumers to scalpers rather than an increase in overall value.

That said, I do agree with Nick Gillespie in that I view ticket scalpers as the people waiting in line so that I don’t have to, and I am happy to use the services that scalpers provide. The difference is that I don’t fool myself into thinking that scalpers automatically help everyone- the ticket that I bought at a high price from a scalper is a ticket that somebody else couldn’t get at a low price from the box office. In addition, ticket scalpers often find it profitable to keep prices high and not sell all of their tickets, which means that fewer people are able to see the event and inefficiency is created.

Segment 4 – Organ Markets: Again, this scenario is remarkably similar to the price gouging situation, since the government has essentially set a price of zero for human organs and massive shortages have developed. It seems likely in this case that a higher price would induce more supply, which is good, but it’s important to keep in mind that the higher price may or may not actually reduce demand, since transplant costs are usually not paid directly by the organ recipients. (Reducing demand for organ transplants is also a sticky ethical issue and not necessarily desirable.) The question of who pays for the transplant organ also gets into tricky ethical territory, since again it’s difficult to equate “can and will pay more” with “needs more.” Overall, I find it interesting that the ethical concerns in organ markets are usually focused on the suppliers rather than the consumers, whereas I, as a potential consumer, would be worried about getting priced out of the transplant market.

Segment 5 – Insider Trading: In a transactional sense, the stock market doesn’t actually create any value- i.e. if I profit from making a particular trade, then whoever made that trade with me lost out. (For example, if I buy a stock at $20 and it goes to $25, I made $5 but the guy who sold me the stock missed out on making another $5.) Economists call this a zero-sum game, since one guy loses what the other guy wins. Therefore, in the long run, insider trading merely changes the distribution of value rather than the amount of value created. As such, I don’t find the legality of insider trading to be a particularly interesting issue- there’s some vague benefit in prices reflecting all information as soon as possible, but I feel on some level that this point was put on the list as an excuse to express a contrarian viewpoint. From a fairness perspective, I would prefer that company employees not be able to profit off of the fact that they know earlier than everyone else that their poor decisions turned the company into a pile of crap. 🙂

Segment 6 – Printing Currency: I’m not sure I quite get this segment, since I was under the impression that it’s illegal to mint coins but okay to make paper currency as long as it doesn’t seem like it is intended to counterfeit actual currency. (I’m a little perplexed as to why this was never pointed out during the show.) There are numerous examples of communities that have done just that (Ithaca Hours, BerkShares, etc.) in order to encourage local spending, and they haven’t gotten hauled off en masse by the Feds just yet. I’m not sure why there is the specific distinction in the law between coins and bills, but the accusation that the government just wants to keep control on the currency supply seems a little absurd when there are legitimate examples of “competing” currencies.

Segment 7 – Legalizing Sin: What Boaz and Gillespie said, times a million. That said, the analysis of what activities do and don’t harm others must be carefully considered, since the answer isn’t always obvious.

Whew, that was long…next week I’ll bring you “Grading John Stossel, Volume 2,” complete with a pretty hilarious debate on gay marriage.

Tags: Econ 101 · Policy

5 responses so far ↓

  • 1 Russ Nelson // Sep 7, 2011 at 6:21 pm

    Part of the reason for anti-gouging laws is that politicians don’t WANT the market to work. If generators ordinarily sell for $1,000, and there’s been an ice storm, and generators sell for $2,000, and you have a truck-full of generators, you’re going to do your damnest to travel through the affected area to where generators are needed most. Well, that gets in the way of the politicians’ plans for travel bans & such.

  • 2 Punditus Maximus // Sep 8, 2011 at 12:38 pm

    No, that’s not why politicians are worried about price gouging.

  • 3 Amarsir // Sep 9, 2011 at 8:44 pm

    The Econtalk podcast between Russ Roberts and Mike Munger was one of the best resources on price gouging I’ve ever heard. (They must be excellent professors as both are quite easy to listen to.)

    For ticket scalping, while pricing above the market-clearing price does create inefficiency, is there a term for value that’s created by not clearing the market? There is a benefit to having access to tickets at the last minute, which wouldn’t be possible had the market been cleared.

    The printing currency bit sounds interesting, I’ll have to make time to watch (haven’t yet). I remember expressing the view years ago that Gift Certificates are basically currency except in name, in light of which we must admit they’re printed everywhere.

  • 4 aesthete // Sep 12, 2011 at 11:50 pm

    Hmm — I never thought you’d give Stossel such a positive rating. (Well, it seems positive compared to how you rate other generally right-wing fixtures, anyways 🙂 )

    Regarding insider trading, it seems to me that the person selling the stock is only at a loss if he or she places no value on the liquidity or the security of his assets. In my experience, both concerns seem to be paramount on the seller’s mind, such that the probability of a stock going from $20 to $25 tomorrow is not worth the risk of keeping that stock. The stock market is certainly vulnerable to information assymetries, but seems to present decent arbitrage opportunities. (Though perhaps increased arbitrage in financial markets might not be a “positive” in your books, heh.)

  • 5 Brian G. // Sep 19, 2011 at 3:01 pm

    I think you missed a fundamental component of the price-gouging issue when you claimed that higher prices won’t get consumers more of a good if companies do not produce more. This is false, as higher prices encourage goods to transfer from other markets where they are in lower demand and into the local disaster area where prices are higher. Indeed, we’ve seen people be arrested for buying generators in one state, driving hundreds of miles to disaster areas and making them available at the new market price. Yes, the total national supply remains the same, but the supply is made more concentrated where the need is higher thanks to the difference in relative prices. But because of price gouging laws, those are the kinds of targeted increases in supply that are not allowed to occur.

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