Arnold Kling  

The Case for Price Gouging

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C.C. Kraemer argues that laws against price gouging are a bad idea.


rather than harming the victims, the profit motive actually helps them because the result is an increase in supplies. That assures that everyone who needs the plywood will get it, an unlikely occurrence if prices are not allowed to rise. When the stores are empty because there were no price signals to protect supplies or to create an increase in them, what does a family desperately in need of a generator or propane lanterns think of the laws that they were told were intended to shield them from avaricious businesses?

I would add that laws against price gouging also reduce the incentives for businesses to maintain inventories of supplies in anticipation of possible storms.

UPDATE: Tyler Cowen has some opinions.

For Discussion. If you needed something after a disaster, which would anger you more--finding that a store had run out of something or finding that the store was charging five times the usual price for it?


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CATEGORIES: Price Controls



COMMENTS (14 to date)
Monkeyspit writes:

There is always limited resources. So going to the store and finding they are out of an item would make me upset. Then upon discovering how much higher they were charging for that missed item I would make me feel elated. Really, it is a lose then win situation.

Anyway, if your frantically running around trying to buy up duct tape to save yourself from chemical or nuclear attacks, chances are you a moron anyway. A fool and his money are soon parted...or in this case departed if the person really thinks duct tape is going to save them.

If you are going to stock up on anything I would suggest canned water. I have the very last can, but for the right price...:)

Brad Hutchings writes:

This is likely off-topic and I may be wrong, but...

I found an old book (which I never read) from a college class that I probably didn't pay any attention to 13 years ago called "Influence: Science and Practice" by Robert Cialdini. It may or may not be a classic in the field. I just know that it was $14 new at the time and still in new, unused condition when I found it recently.

Anyway, Cialdini makes an observation that if you append any BS reason to a request, it will make even the most ridiculous request palatable to the uncritical thinker, which most of us are most of the time because it's too much effort to question everything. So, if you're at a bar and see a cute young lady, you're more likely to be successful with "How about if you come back to my place so we can improve the GDP of Elbonia?" than with "Would you like to come home with me?". Make sense?? Anyway, after I read this observation a couple weeks ago, I see and hear it everywhere. The savvy people are doing it consciously and even the not so savvy stumble into it. And then there is this one posers I know who is spending $8000/year to learn to use language powerfully. Everything that comes out of his mouth is phrased this way, although he's just not good enough at it to avoid my BS detector.

So, let's consider the price gouging issue. "There should be laws against price gouging because we need supplies at a reasonable price in emergencies." Suggestion followed by total BS reasoning. Yet, it probably makes sense to most people and draws upon their sense of fairness, etc. I mean, who could possibly argue against this point except an economist or someone who beats up puppies?

If we're going to argue this point effectively, we need to pull a page from Cialdini's book. "We need to ENCOURAGE price gouging because it makes it worth it for suppliers to quickly get us the things we need in an emergency."

Whaddy'all think?

-Brad

Matt Young writes:

My kindgom for a horse!

Jim Glass writes:

"...That assures that everyone who needs the plywood will get it, an unlikely occurrence if prices are not allowed to rise. "

Not really, as the whole point is that the amount demanded by people who have some need for it will exceed the supply at a low price.

Rather, the rising price will allocate it to those who need it the most, those being assumed to be those who are willing to pay more.

That's not a perfect assumption, and the problems with it that are easy to see may be what leads to "anti-price gouging" laws.

However, the reality is that it's a much better working solution than keeping the price too low and having the item allocated by random chance, favoritism or worse, without factoring in need at all even imperfectly.
~~~~

"'There should be laws against price gouging because we need supplies at a reasonable price in emergencies.' Suggestion followed by total BS reasoning. Yet, it probably makes sense to most people and draws upon their sense of fairness, etc."

That's been the exact rationale for rent control laws here in NYC during the "temporary emergency" that's existed since World War II. Same damn thing.

"I mean, who could possibly argue against this point except an economist or someone who beats up puppies?"

Yup, the only people who argue against rent control too.

Jim Glass writes:

re Tyler Cowen's comments:

"Kraemer suggests that we should allow price gouging in times of emergencies. This policy conclusion need not follow.

"Since supply is constant in the short-run, higher prices won't give more flashlights to more people... Higher prices will allocate flashlights to those people most willing to bid for them, but at the cost of all buyers feeling gouged.

"After all, not wanting to be gouged is a preference too. And the subsequent decline in trust will eliminate other potential gains from trade."
~~~

This by itself is perfectly valid. During the big blackout not so long ago I was quite taken by how none of the local stores around here in Manhattan raised their prices for anything, even though there was huge demand and long lines for things like batteries, ice, food, and so on, and they easily could have.

I thought at the time that what Cowen describes above was happening -- the local store owners knew they'd have to face the same customers the next day when the blackout would be over. Then the customers would be pissed, and ouch.

BUT Cowen's observation that therefore Kraemer's policy conclusion that price gouging should be legal "does not follow" itself does not follow.

Price gouging should be legal and left to the market. In my case during the blackout there was no really big payoff to merchants or benefit to society from to jacking up prices, so the market decreed that it not happen.

But if a hurricane is coming and only a limited amount of building supplies are available to use to save very valuable properties, that's a whole different situation.

It doesn't pay then to apply the NYC blackout analysis to keep "fair prices" and have the bulding supplies get allocated by a contractor to his brother-in-law to brace his garage while somebody else's Crystal Palace gets destroyed in spite of the fact that its owner would have paid top dollar to save it had it legal for him to do so.

Lawrance George Lux writes:

There is no increased Production in the Short-run. Higher pricing during emergencies suppose a spreading base of Supply, higher prices inducing more Suppliers to enter into Overtime Production to make up Storage losses. The added Price pays for the Overtime costs, and anger of established Customers over shortages of their own supply. This is the theortical argument for Price-gouging during emergencies.

Reality states Transportation and Overtime costs are over-compensated; still, there is the need to induce Suppliers to supply, bearing the added costs. Federal regulation could limit Price rises to Fifty percent of orginal cost during emergencies, but the effect might be detrimental. lgl

Boonton writes:

Overlooked here was the observation that the possibility of gouged profits would make it profitable for stores to keep extra inventories on hand. Many outfits are now running with just in time inventory systems & view inventory as an unproductive and risky asset that must be keep as low as possible. When a sudden or unexpected diaster does hit this gain in efficiency will result in a shortage.

Patrick R. Sullivan writes:

Suppose I receive a telephone call from Jim Glass lamenting the dearth of flashlight batteries in NYC a mere two weeks before he and friends plan to go on a camping trip. He inquires if I would have any I could spare if he would reimburse me.

I scrape up 10 that cost me $1 each, and UPS them to NYC for (I just looked it up) $6.50. Jim has the batteries one week later, in plenty of time for his trip. At a cost of $1.65 per battery.

Now, suppose Jim calls me on the day of the blackout, and needs the batteries pronto. They still cost me $1, but the UPS charges for Next Day Air Early AM are $66.50 (again, I looked it up in my UPS Rate Guide). Now, each battery has cost Jim $7.65, nearly 5 times as much. Because he needed them in entirely different circumstances.

Now you know all you need to understand that "price gouging" is oxymoronic. Because our private transaction would be mirrored by the commercial transactions among wholesalers and retailers.

Boonton writes:

What you're describing is not price gouging, though. The typical example of price gouging is batteries that cost you $0.50 wholesale that you typically sell for $1.10 retail, now because of the blackout you sell them for $3.50. The natural diaster is a pure windfall for you because your cost remains $.50 while your revenue explodes.

Brad Hutchings writes:

Boonton writes:
"The natural diaster is a pure windfall for you because your cost remains $.50 while your revenue explodes."

I could be wrong, but I think that with contentious issues like this, we need to ask ourselves, "What would Clinton (or Blair, or any other third-wayer) do?". And the solution is obvious. Elevated prices serve as an important market signal. If the price of batteries does not go up to a point where consumption is discouraged, then good bye batteries, and good bye grandmas ventilator when her batteries run out (well, ok, that rhetoric is a little bit excessive, but this is a "What would Clinton do?" exercise).
At the same time, nobody should profit excessively from a disaster of such epic proportions as a blackout. So I think there should be a law that expressly allows and encourages price gouging in emergencies and directs vendors to donate their excess profits to the Kling Center for Basic Encononic Education.

But seriously... Boonton's criticism is the root issue. I don't think it's that people resent paying more for goods during a period of constrained supplies. They resent anyone making money off the problem. For example, gas prices in SoCal have just nudged back under $2/gallon for regular unleaded (still less than half the price of the govt enforced price of milk) after a sharp spike due the pipeline issue in Arizona. And we have one of the two candidates likely to replace Governor Gumbie advocating wholesale price controls of gasoline. No kidding. He hasn't discussed whether we he would have rationed the gas or let Arizona slip into pre-industrial chaos.

-Brad

Bruce Shrock writes:

Price gouging does not offer an economic incentive to overstock for emergencies.

Assume Home Depot can either stock pressure washers or electrical generators. They can turn over the pressure washers 4 times a month, realizing a profit of $50 on each transaction (10% of $500 per sale) for a total of $200 a month for each pressure washer stocked. Granted, pressure washers aren’t a high turnover item, but people do occasionally realize their driveway is in a shocking state and wish to clean it. On the other hand, the only time anyone purchases a generator is when their power goes out.

Assuming a widespread outage twice a year, if Home Depot wanted to stock emergency supplies and profit through price gouging, they would have to recoup at least $800 on each generator they stocked. Keep in mind that in an emergency, there is no ability to restock so the entire profit must be realized in one sale.

Jim Glass writes:

"What you're describing is not price gouging, though. ... The natural diaster is a pure windfall for you because your cost remains $.50 while your revenue explodes."

Which is exactly the same thing that happens in any market transaction in response to sudden increase in demand.

When you fly booking a seat on short notice why will you pay 10x as much as the person sitting in the seat next to you who booked a month in advance? Your seat doesn't cost the airline any more then the other. You are just being "gouged" because you need it on short notice. Why does FedEx charge 10x as much to ship batteries overnight than next week? It doesn't cost FedEx ten times as much. It's just gouging the rush-order customer.

Of course the "windfall" argument is the political reason why laws against price gouging exist.

But it completely ignores the allocation role of pricing, which sends the goods to whom they are most important. The person to whom it is most important to get a seat on the airplane *today* will pay the most for it. If the airline is legally barred from raising its price for the seat as the result of an "anti-price gouging law" because its cost for the seat hasn't gone up, then it may face 10 people who would like the seat but don't really need it in a line haggling over it, while the guy who's missing the funeral of his mother is #11 in line.

This also creates the incentive for whoever really needs the seat most to to buy it for cash from whoever gets it by chance for the low price from the airline -- creating a black market with market prices paid for airline seats but not to the provider of airline services, but rather to parasites who game the system.

It's the same thing when building materials are needed by some people on short notice -- whether due to a coming storm or otherwise.

BTW, while the argument is often made that anti-gouging laws and the like are needed to prevent businesses from reaping "windfall gains" from sudden increases in demand, I haven't often seen the argument that laws are needed to prevent businesses from suffering "windfall losses" due to sudden drops in demand.

Except in the case of farmers, of course.

FN: I just read that airline "bereavement fares", which used to be sympathetic bargains, now typically cost more than regular fares avalable through airline web sites. There's gouging for you!

Patrick R. Sullivan writes:

" What you're describing is not price gouging, though. The typical example of price gouging is...."

My point is that there is no such thing as "price gouging". There is price, which fluctuates due to changes in circumstances.

Sometimes due to drastic changes; to borrow from Tom Sowell, a gallon of water is "priced" very differently at the tap in my home, than in the middle of the Sahara desert. And even within my home the "price" is drastically different depending on whether I need a glass of water to drink or have a flooded basement.

"Gouging" refers to unilateral action by one person against an object. Pricing is bi-lateral.

We should all pay the price of failing to meet requirements. That way we may improve by investing to prevent failures to meet requirements.

It is far better to invest in being prepared for the event (to meet requirements) than to ignore the warnings and then having to pay the considerably higher price of not meeting the requirement.

Anti-price gouging laws come from a nanny state that encourages complacent but grateful citizens. Such citizens are likely to vote for someone who will continue to rescue them from their own unwillingness to invest in the prevention of their failure (or assured success/happiness).

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