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Allowing Price Gouging Is The Worst Form Of Policy, Except For All Those Other Forms That Have Been Tried From Time To Time…

November 3rd, 2012 · 9 Comments
Econ 101 · Policy

(Churchill must really be rolling over in his grave with that one. My apologies.)

After basically every natural disaster, the tried and true (yet ignored from a policy perspective) articles on price gouging show up. The general theme goes something like this:

People: Price gouging, or sharply raising prices in response to temporary demand increases brought on by a crisis, just exploits consumers and therefore should be illegal. (It is, in fact, illegal in most jurisdictions.)

Economists: Actually, what you are calling price gouging is just the result of regular forces of supply and demand. Prices are generally viewed as an efficient way of rationing or allocating goods and services, and allowing prices to increase would ensure that the gasoline/water (I will stick to those two examples since they seem to give rise to 99.99% of price-gouging articles) gets to the people who value them most. In addition, the higher price could give suppliers an incentive to stay open in crappy conditions and/or get more supply to the areas where it is needed, even if doing so is expensive. If nothing else, it’s important to keep in mind that not everyone can get what they want or need at the lower price.

People: Just because something happens in a free market doesn’t make it fair. You economists are all alike- you just want to see a world where rich people get all of the stuff.

Some Economists (implicitly): Yes, yes we do.

Other Economists: Sigh. Is this any less fair than the stuff going to whoever happens to get in line first?

Other Economists (including yours truly): Hmmm…okay, yes, there is a bit of an issue with the line “gets to the people who value them most” as it relates to efficiency. We acknowledge that value is an intrinsic thing that we are trying to proxy using a a consumer’s willingness to pay (which is of course limited by ability to pay), whereas willingness to pay as a measure of value isn’t necessarily comparable across consumers of different wealth levels.

People: *blank stare*

Other Economists (including yours truly): In other words, Warren Buffett is probably willing to pay more for a gallon of milk than I am, but technically we can’t tell whether Warren Buffett likes or needs milk more than I do or if he just values his money less than I do because he has so much of it.

People: Obviously.

Smart People: Wait- wouldn’t this imply that high levels of income or wealth inequality undermine the conclusions that economists draw about the efficiency of free markets? (This isn’t a thing quite yet, but it’s been brought up to me at least once.)

Economists: Uhhhhhh…

The last point made above is a valid one, but casting doubt on the true efficiency of price gouging doesn’t make shortages and people waiting endlessly in line for gasoline/water any more efficient. Therefore, I would like to implore the world to take a slightly more nuanced approach to thoughts on price gouging. Some resources to get you started:

Are you convinced yet? Didn’t think so. As a last-ditch effort, I would like to introduce you to a few representative scenarios that arise in the absence of price gouging:

  • @ErikaMillerNBR: PHOTO: Gasoline shortages in NYC metro area. 30+ block wait. I would like to point out that this is 30 blocks of pedestrians with plastic jugs, not 30 blocks of cars. Regardless, sounds fun! Totally better than paying more, especially when you factor in the excitement that I get from the uncertainly surrounding whether or not gasoline will run out before I get to the front of the line.
  • Rationing: Governor Chris Christie recently instituted a policy in some counties that people are only allowed to refuel their vehicles every other day. As someone who fills her as tank about once a month, I can’t help but envision a profitable but inefficient business scenario where I fill my tank every other day and then sell the gas to the people who actually need it to get to work and such. I guess my overall point is that fair/efficient rationing requires a ton of knowledge about the idiosyncratic needs of consumers- needs that are hard to uncover but are conveniently incorporated into consumers’ willingness to pay for goods and services. (On a related note, who needs to fill their cars more than every other day anyway? It seems like the only way this policy would have an impact is if people were seriously hoarding gasoline before the policy took effect.) I think this notion is summed up by a choice quote from the New York Times: ““Everything is flowing now, but you have people coming in with three-quarters of a tank blocking people who really need it,” Mr. Manicchio said. “People aren’t being rational.” Sure they are- they are being rationally self-interested. 🙂
  • Jackasses try to cut in line and then pull guns on people when they try to complain. I might get shot, but at least my pocketbook won’t be dead! *rim shot* I would also like to highlight the cost of having police monitor the gas stations because people are upset and increasingly unable to act like reasonable humans. (You may not have gotten gouged on your gas, but you will on your taxes!)

I’d like to think that I’m not totally being unreasonable here, so I will throw the fairness police a bone and suggest that a better policy would involve some sharing of the excess profits between the gas stations and rescue organizations or something like that.

In what might be the ultimate irony, gas prices nationwide have decreased a bit because, you guessed it, demand drops when people’s cars get washed away by a hurricane and aren’t being driven to work.

UPDATE: One thing that is important in this discussion is what value people place on the time that they spend waiting in line. For fast food drive thru lines, at least, this value is $144 per hour. This is an irrational overestimate of course, but it highlights the principle that long lines are, among other things, an implicit form of price increase.

Tags: Econ 101 · Policy

9 responses so far ↓

  • 1 Renegade Division // Nov 3, 2012 at 7:11 pm

    I’d like to think that I’m not totally being unreasonable here, so I will throw the fairness police a bone and suggest that a better policy would involve some sharing of the excess profits between the gas stations and rescue organizations or something like that.

    Wouldn’t this defeat the point of allowing price gouging?

    The above quote and the article misses one important thing. If there was only X liters of gasoline available say per week or per day, and there is no way this supply could be increased then sure ration it out, hold lucky draws, distribute it howsoever you want. There is absolutely no reason why you should sell it to the guy who can pay the most price for it.

    But that’s not the case, by allowing higher prices you attract more gasoline for people in this area. There’s a time lag involved but the increased profits incentivizes people around the neighboring areas, the areas unaffected by the calamity to reduce their consumption of gasoline(by incentivize I mean higher prices), and this gasoline is sent over to the affected areas.

    By saying that excess profits should be distributed between station owners and rescue organizations you’re defeating the whole point of allowing price gauging.

    Say gas prices reach to $100 per gallon. This sounds like a HUGE profit for gas station owners, but this really means that people are in THAT dire need of gasoline. Also not to mention the $100 per gallon is only the price for a few units of gasoline, then price would start to fall again.

    Either way allowing gas station owners all the profit they can, allows the whole supply chain to work with more efficiency and output.

  • 2 BoZimmerman // Nov 3, 2012 at 7:29 pm

    The stories of hillbillies filling pickups with bags of ice or Generators or something desperately needed, yeehawing their way into disaster zones in their 4x4s, only to get shutdown or arrested for price gouging stack up like sad little sands on the beach of economic illiteracy. When I think about price gouging laws, I don’t think about relative efficiency, I think about meeting the threshold that keeps humans in disaster zones alive at all.

  • 3 bdbd // Nov 3, 2012 at 7:42 pm

    with price gouging the guy with the gun is more likely to turn it on the merchant than on the person in front of them in the line

  • 4 econgirl // Nov 4, 2012 at 10:57 am

    @ Renegade Division: Right- the donating/taxing/etc. of price gouging profit would be more problematic in situations where there is potential to get increased supply into the area (since it weakens the incentive to do so to some degree), whereas if supply is completely inelastic all price gouging is going to do is raise prices and give some windfall profit to the merchant. However, the latter scenario is not an argument against price gouging (or a statement on the irrelevance of price gouging), since the higher price gives people an incentive to think about how much they really need the good that is in short supply. (See the quote about the 3/4 full tank person above.)

    @BoZimmerman: I would never complain about some dude in a truck trying to sell me gas at $20 per gallon if I couldn’t get it elsewhere. But I’m glad that regulators are protecting me from such unfair behavior. =P

  • 5 BC // Nov 4, 2012 at 6:07 pm

    “On a related note, who needs to fill their cars more than every other day anyway? It seems like the only way this policy would have an impact is if people were seriously hoarding gasoline before the policy took effect.”

    Actually, people are hoarding, and price controls make hoarding worse. When the price is kept below the market-clearing level, there will be risk of shortages by definition. The risk that gas won’t be available when one needs it (and, for some, the potential to sell gas on the black market at higher prices) induces people to get more gas than they need, “just in case”. That hoarding behavior, of course, increases the risk of shortage even more, thus inducing even more people to hoard. It’s kind of like a bank run, except for gas. Rationing does not help because, as you say, people have different gas needs. With the price controls, everyone is incentivized to get their full ration of gas, even if they don’t “need” all of it. That means that people that do need more gas than their ration won’t be able to buy it.

    As you say, high prices not only incentivize more supply, they also incentivize less consumption and hoarding.

  • 6 BC // Nov 4, 2012 at 6:16 pm

    As far as the argument that “price gouging” is “unfair” to the poor, that is not really different from any other good that we think we should subsidize for the poor. If the market-clearing price of gas is $20/gallon now vs. $4/gallon during “normal” times and we think that the poor should be able to buy gas at $4/gallon, why should the $16 difference be completely subsidized by gas station owners, who aren’t necessarily wealthy, instead of all tax payers, which includes, for example, multi-billionaire hedge fund managers? Also, that $16 subsidy is given to everyone, not just the poor, including again the multi-billionaire hedge fund manager.

    A direct cash subsidy or gas voucher for the poor seems to me to be a much better way to target both the receiver and the payer (through the tax system) of the subsidy.

  • 7 DH // Nov 12, 2012 at 3:29 pm

    Perhaps another alternative is to ration gas that allows a certain amount (say 10 gallons) per person for a few days. While each person is given an allowance of gasoline, citizens are allowed to freely exchange such allowances with eachother for money. This allows the people who need more gas to be able to buy more while at the same time ensuring that ability to pay is not the only pre-requisite for getting gasoline. Plus you reduce the risk of monopolizing by gas station owners who may choose a purposely high price rather than one which is at the market clearing price since it will be the citizens who are selling it to each other rather than the one gas station in town. Just a thought.

  • 8 John // Dec 31, 2012 at 10:33 pm

    Your discussion of price gouging and rationing reminds me of an experience I had in Burma.

    One day our guide told me he did n’t know how to drive. The next day he talked about his car. Puzzled, I queried him. It turned out his car was a pusher – no engine. It was pushed once a month by the guide’s friends to a gas station to get its ration which our guide then sold to others who ran through their’s.

    The Burmese government “solved” its pusher problem by banning all cars – pushers or not – over 25 years of age. This had tragic consequences for our driver. His car, engine and all, was over the limit. The poor guy lost his livelihood.

    One last consequence. When we visited one city we saw a many block area devastated by fire. It turned out that the bus station shad stored hoarded gas in barrels. Some one apparently was sloppy with his cigarette buts.

    This just shows that the consequences of cracking down on gouging go far beyond what we might imagine: “unfairness” to the driver and the loss of six blocks of building

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