David R. Henderson  

Jeff Ely on Price Controls During Disasters

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I had thought that pretty much all economists agreed that price controls during disasters are a bad idea. But Northwestern University economist Jeff Ely has a different take. He writes the following:

But in fact it is quite typical for the consumer surplus maximizing solution to be a rationing system with a price below market clearing. I devoted a series of posts to this point last year. The basic idea is that the efficiency gains you get from separating the high-values from the low-values can be more than offset by the high prices necessary to achieve that and the corresponding loss of consumer surplus.

Why would we only care about consumers' surplus and not also the surplus that goes to producers? We normally care about producer's surplus because that's what gives producers an incentive to produce in the first place. But remember that a natural disaster has occurred. It wasn't expected. Production already happened. Whatever we decide to do when that unexpected event occurs will have no effect on production decisions. We get a freebie chance to maximize consumer's surplus without negative incentive effects on producers.


Given Ely's assumptions--no effect on production decisions--then his claim about maximizing consumer surplus could well be true, for the reason noted in his first quoted paragraph above. Tyler Cowen does a good job of taking on the assumption of no effect on production decisions.

But I want to point out another more-fundamental problem with Jeff Ely's reasoning: his narrow assumption about why "we" care about producer surplus. Jeff writes:

We normally care about producer's surplus because that's what gives producers an incentive to produce in the first place.

I do care about the incentive, but that's not the main reason I care about producer surplus. I care, fundamentally, because producers are humans. They count too. And their property rights count.

I remember years ago a conference I attended with, among others, Murray Rothbard and Walter Block. Walter said, "What's the big deal about consumer surplus? Any schmuck can consume." Murray cackled, as was his wont, and repeated the line. I actually quoted that line when I taught a bunch of federal judges and I was going over the classic 1968 Oliver Williamson piece about economies of scale as an antitrust defense.

I think it would be hard to maintain a coherent ethical system in which producers don't count. For one thing, almost everyone, at least at some point, is a producer. Why care about them just qua consumer.

I do want to thank Jeff Ely, though, for implicitly pointing out a flaw in the way I teach this, and I just taught it last week. I do the whole analysis in terms of the effects on consumers. By doing the same, Jeff reminds me what I have been leaving out.


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CATEGORIES: Price Controls



COMMENTS (20 to date)
BZ writes:

Forgive me please, but I thought the problem with price gouging laws wasn't the amount of goods distributed, but that the wrong people were getting too much, while the most desperate were getting too little. In other words, that prices below market caused a problem with distribution?

My understanding of conventional economic opinion was that during a disaster, the best situation would be for producers all to announce (with price hikes) "We're going to be short on stuff for awhile, so only come to us if you REALLY need it. If you are just stocking up against the 1% chance of being holed up for the next year, stay home."

David R. Henderson writes:

@BZ,
No forgiveness required, but read his piece. He handles your point.

Jehu writes:

The problem is that we don't see producers as human. For instance:

The overwhelming majority of people would not fault, for example, a gas station or grocery employee from demanding a huge premium for showing up to work during a major disaster. We'd 'reason' that he needs to look after his own family under the circumstances/getting to work is dangerous or difficult or the like.
Guess what, that increased cost has to be paid by somebody, and that somebody is a producer.

Also, if you want tertiary, and below that, producers to come out and bring needed things to market, the price offered has to be high enough. What price, for instance would be enough to induce a few rednecks to rent a panel truck, load it up with necessary goods, use chainsaws to clear fallen trees in their path and other debris, and bring, say, bottled water and the like to your neighborhood from less affected counties?

Joe Cushing writes:

"Production already happened. Whatever we decide to do when that unexpected event occurs will have no effect on production decisions. "

This is short sited, wrong headed, and simply not true. I can give a two examples of how this is not true. I'm sure the market could come up with thousands of more examples.

Example 1: Transportation of needed supplies to a disaster area. I once heard a story about some guys who rented trucks, bought generators at retail and drove them to a disaster area (I assume great distance). They sold these generators for a profit which meant marking up above the retail they paid, enough to pay for their cost of transporting and their time. The generators were confiscated and nobody got to use them. There is a similar story involving Ice.

Example 2: This one is hypothetical. A gas station typically does not keep a generator on site. It's possible that without gouging laws, these gas stations might be incentivized iced to buy a generator. If a gas station owner knew he/she could charge triple the price in a power outage situation, this might pay for the price of the generator and the risk that the investment in the generator will never pay off.

Ken B writes:

To second Joe Cushing, I can think of several things that are sold and stocked principally for use in disasters and disruptions. Aside from obvious examples -- generators, first aid kits -- you an still buy small pills for example to put in a bottle of lake or tap water to purify it.

I saw one blogger suggest that in times like these beer makes a great liquid currency because people will take it when stores close so a $20 is not immediately useful. That not only suggests we don't want price controls on beer, it suggests pent up demand for more mundane stuff.

Contrary to Jehu, the overwhelming majority of consumers have little idea about the excess expenses and risks associated with maintaining supplies and availability during emergencies. States with anti-price gouging laws regularly penalize businesses, sometimes thousands of dollars in penalties, after consumer complaints of 'too high prices' and a government investigation.

The investigation typically considers well documented cost increases as a defense, but increased retailer risks and increased opportunity costs almost never persuade state investigators that price increases are justifiable.

Ted Levy writes:

The following off-the-cuff thoughts are made, sadly, without the time to read Ely's no-doubt interesting article, and thus may suffer from making claims Ely has in fact dealt with...

Ely's point may well make sense for ONE emergency. But I'd guess producers learn from experience. If they lost money supplying an area hit by an emergency last year due to regulations preventing them from charging appropriate emergency prices, I would assume at the margin they become somewhat less enthusiastic about supplying goods for the next emergency.

Also, I'm unclear why "production has already happened" because "emergency" is equivalent to "unpredicted" makes sense. First, this Frankenstorm was predicted over a week ago, but that doesn't make it any less of an emergency. I'm guessing at least SOME goods needed in an emergency have a production process of less than a week. Second, the issue isn't purely production, right? It's also distribution. If I run a company that makes 1,000,000 batteries a week. The issue isn't "will I gear up to make 2,000,000 in an emergency?" it's "Will I ship a greater percentage of the 1,000,000 than I normally do to the 'disaster zone'?". Doesn't the answer depend on whether or not I profit from doing so?

Costard writes:

David: He really doesn't handle BZ's point. How can you possibly measure the value placed on a commodity by someone who risks injury or death if they can't get it? We only know values through prices, and these become chaotic and oftentimes immeasurable in a crisis. The idea that you can ignore outliers when maximizing "surplus" is that same fallacy that sunk the banking system. At the extremes - and in moments of real desperation - values can approach infinity.

Even if Jeff were right, his point would be irrelevant. Rationing is something decided a priori. It is certainly not the result of economists making rational analyses as the world crumbles around them. Part of a natural disaster - of any crisis - is the failure of the flow of information. If benefit could be maximized at a lower price, we would not know it at the time, and regardless, this maximization would almost certainly be achieved at a higher human cost.

I'm sure Jeff means well, and in any event he's defending a status quo rather than advocating something new, but I wish he'd lose the sterilized vocabulary. He's discussing something very serious, and even if he realizes it, he has a responsibility to his readers to ensure that they do as well.

Ryan Vann writes:

I'm with Costard on this.

When Jeff writes,

"But what if you don’t want to maximize total surplus but just want to maximize consumers’ surplus? "

he kind of misses the point entirely. A catastrophe is no time to be waxing on about optimization. The important thing during a catastrophe is for people get the survival goods they need, and if people are going to risk going into disaster areas to supply it, beyond extreme charity, a flexible price system is necessary.

MingoV writes:

I don't accept Ely's arguments, but let's assume they are valid. Do Price-Setters and Rationers magically appear in stores and businesses after every disaster to determine the proper prices and proper allocations of selected goods and services? If not, then who makes the pricing and rationing decisions?

Peter Klein writes:

David, I made your argument once in an exchange with Larry Lessig, who was arguing for outlawing bundling and tying on the grounds that only consumers should decide what products are bundled or tied. "If the law forbids bundling, then the freedom of sellers to choose the products they offer has been curtailed. In other words, maximizing the buyer's range of choices imposes costs on the seller, just as maximizing the seller's range of choices may impose costs on buyers. Why should the latter trump the former?" He responded that he agreed, but that my point was trivial and irrelevant for practical purposes!

Scott Sumner writes:

Great minds think alike. Except I said producers were people, and you said they were humans. Close enough.

http://www.themoneyillusion.com/?p=17400

David R. Henderson writes:

@Peter Klein,
Wow!

David R. Henderson writes:

@Scott Sumner,
Good post. Thanks.

Glen Smith writes:

Depends on which side people like you are on. For instance, in my profession, software engineering, few of those in my profession complained when the demand for their services outstripped supply so they could charge big money for very little work but now that the supply of quality software engineers outstrips demand, they complain instead of adjusting.

David R. Henderson writes:

@Glen Smith,
Your sentence lacks a subject. What depends?

JeffM writes:

I have been doing some work on famines (I mean real famines where millions of people die of starvation). I have come to the same conclusion that Adam Smith did long ago: price controls on food have bad effects in both the short term and the long term and both increase the risk of famine and exacerbate famine when it occurs.

What seems to me as probably the best approach is for purchases at market prices by the state (or some other agency responsible for relief) and distribution at affordable prices to those who cannot maintain health at market prices. Malthus pointed out that such a process (which essentially was what happened under the Elizabethan Poor Law) creates a dynamic feedback loop that drives market prices higher, thus increases the number who cannot afford to maintain their health at market prices, and thus increases the fiscal strain on the relieving agency. It is this strain that makes the relieving agency an advocate of price controls, and the relieving agency has great moral credibility when it advocates during a famine. Notice that the market-price approach does not disrupt the normal market mechanism except by shifting effective demand to those at risk from those not at risk. Producers' incentives are actually enhanced as are the incentives for holding reserve stocks in good times.

Tracy W writes:
I think it would be hard to maintain a coherent ethical system in which producers don't count. For one thing, almost everyone, at least at some point, is a producer. Why care about them just qua consumer.

I think Ely was just drawing on Adam Smith's comment, that the whole point of the economy is to consume, and the needs of producers should be attended to only as much as needed to induce them to consume.

I don't think that either Ely or Adam Smith were advocating denying producers' human rights (or in Smith's thinking, reasonable administration of justice, as I can't recall him using the phrase "human rights"). Just that the welfare of producers as distinct from consumers is not a matter for public policy.

Ritwik writes:

Jeff Ely has responded to this point in his next post.

http://cheaptalk.org/2012/10/30/the-price-mechanism/#comments

The argument basically is not about placing a 0 weight on producer surplus. It's about not arbitrarily changing the relative weights of producer and consumer surplus in response to a natural disaster.

Richard writes:

When did highly educated people lose the ability to use simple punctuation marks?

Check out the first paragraph of the block quote. Ely needed to hyphenate "consume surplus maximizing solution," but he didn't. Then he compounded the error two sentences later by hyphenating "high-values" and "low-values," neither of which should have a hyphen.

If you don't know why, I suggest you look it up. The rules of punctuation are not arbitrary; they exist to make things easier for readers. That means that poor punctuators are selfish.

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