David R. Henderson  

Thaler on Price Gouging

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In a segment on the economics of price gouging on NPR Marketplace last Friday [it starts at about the 11:40 point], my former University of Rochester colleague Richard Thaler points out that merchants who price gouge create ill will among their regular customers that will come back to bite them later. He's right. In response, Don Boudreaux lays out clearly both the fact that Thaler is right and, more important, the fact that this does not undercut the case for allowing price gouging. Don writes:

Yet surely no one is more aware of this downside of "price gouging" - and more interested in avoiding it - than are merchants themselves. Therefore, if after a natural disaster we nevertheless witness significant price hikes, we must ask why the price-hiking merchants are knowingly risking their reputations with consumers. The obvious answer is that the natural disaster caused supplies of goods to fall so extremely that it pays merchants to raise prices even though doing so imperils these merchants' good reputations.

There's another point to make too. We economists point out, as I did here, that the higher prices during emergencies attract resources--water, plywood, etc.--from other parts of the country. Think about who those people are who are supplying the resources. The obvious point is that they probably wouldn't do it if they were not allowed to charge higher-than-normal prices. The more-subtle point is that they don't have to worry about lost good will from future customers because many of them are engaged in one-time transactions. The guy who thinks to buy a lot of cases of water in advance and then sell them to others may not even be in the water business. He's simply trying to make a buck by doing something that buyers show by their actions is very valuable.

As I pointed out in my interview, by allowing price gouging, we get, to some extent, the best of both worlds. We get the traditional merchants like Wal-Mart, who worry about reputation, stocking certain supplies in advance and not raising prices. We also get the fringe, one-time suppliers, bringing in more supplies in response to the higher prices they can charge.

I found this quote from Thaler, at the 15:09 point, economically illiterate:

A time of crisis is a time for all of us to pitch in; it's not a time for all of us to grab.

Remember that he said this in the context of opposition to price gouging. But what price gouging does, as Don Boudreaux points out, is cause people far from the crisis spot to pitch in by temporarily foregoing buying the water, plywood, etc. that, due to price gouging, are priced higher even outside the directly affected area.

P.S. If you're inclined to dis NPR Marketplace, then listen to the whole thing. It goes only about 4 minutes. They do a nice job, calling on two economists and one philosopher, of laying out the beneficial economics of price-gouging before going to Thaler to give an alternate, if badly thought out, counterpoint. My one criticism is that the host, Kai Ryssdal, leads by saying that "the free market is cold-blooded, heartless." He never says why, assuming, as he probably knows he can, that most of his listeners will agree with him.

COMMENTS (24 to date)
EclectEcon writes:

Something missing from all the defenses of price gouging is that the EXPECTATION of being able to charge higher prices is one thing that moves resources in anticipation of the natural disaster (in the cases of flooding and hurricanes, and even to some extent ice storms and fires). It is also the EXPECTATION of lost good will that keeps some merchants wanting repeat business from charging higher prices. In most of what I've read about price gouging, the word "expectations" is missing.

David R. Henderson writes:

Good point, and you’re right that we should be making it and making it more often. Thanks.

Don Boudreaux writes:

David: Nicely done (and thanks for the plug). Reading your post brings another, related point to mind. Thaler famously endorses the findings of behavioral economics (I believe with good reason). Behavioral economists are fond of pointing out how people's alleged 'irrationality' prompts them to behave in ways that both run counter to the standard predictions of neoclassical economic theory and that are often less individually and socially beneficial than would be actions more in accord with neoclassical predictions.

Yet in this case we have Thaler bemoaning the fact that individuals behave in accordance with the predictions of neoclassical economic theory! We have Thaler arguing for actions (and policies?) that cause the market to perform more poorly than it would perform if Thaler's advice were ignored.

Thaler might respond that merchants who raise prices in emergencies in fact - because of cognitive limitations of the sort highlighted by behavioral economists - behave contrary to their own best long-run interests. But as I point out in the Cafe Hayek post that you link to above, it's at least an open question if such price-hikes run counter to merchants' long-run best interests. Either way, the consumer hostility to "gouging" prices that Thaler identifies is one that has the peculiar property of suggesting to behavioral economists that people's behavioral quirks and irrationalities spark an irrational demand for more government intervention than is wise. This is peculiar because the typical behavioral economist concludes that correcting for people's behavioral quirks and irrationalities requires more government intervention rather than less.

David R Henderson writes:

@Don Boudreaux,
Very insightful. Thanks.

Rickjon writes:

I take issue with the last sentence: "He never says why, assuming, as he probably knows he can, that most of his listeners will agree with them without doing any thinking themselves." This is an example of the pointless and usually flawed editorializing that so often diminishes otherwise straightforward analysis.

Agreeing with someone does not automatically indicate that you are not doing your own thinking. Kai's assumption in making the statement is indeed that his listeners agree, but he makes no assertion implied or explicit as to how they came by that belief. Some of them believe it unthinkingly, influenced by their particular culture and community, and some of them have interrogated their beliefs and come to the same conclusion by a much more rigorous path. The same of course can be said of free market proponents - they come in all varieties of free thinkers and blind followers.

Hazel Meade writes:

Yes. Often the price gougers are not the local merchants, but someone further up the supply chain who is making a one time sale to the local merchant. So it's often unjust to blame the local merchant. In cases like this the laws against price gouging act just like price controls - forcing people to sell products below cost, which results in shortages. Meanwhile, it would be crazy to punish the one-time suppliers further up the supply chain, since they would just stop selling into the local market in the disaster area.

David Boaz writes:

Note that you probably heard this on your local public radio station where you hear NPR, but this is actually Marketplace Radio, which is not part of NPR.

I've recently noted on Facebook a couple of good reports on trade that Marketplace did.

David R Henderson writes:

Good point. I took it to heart and edited accordingly.

john hare writes:
Rickjon writes: I take issue with the last sentence: "He never says why, assuming, as he probably knows he can, that most of his listeners will agree with them without doing any thinking themselves." This is an example of the pointless and usually flawed editorializing that so often diminishes otherwise straightforward analysis.

As part of a project of mine, I listen to a mixture of "Liberal" and "Conservative" radio when in the truck. It is amazing how often both of them make statements of that nature. Many people seem to think an insulting reference to the other side is making a point when it is just mindless bashing in the manner that David mentioned.

I can only take either side in small doses because of that type of non-thinking. Attempting something like that on this site would get me corrected by multiple commenters even if it made it past moderation.

Mark Barbieri writes:
it's not a time for all of us to grab.

It is the failure to raise prices encourages "grabbing". I live in the Houston area and just before the storm came in, I filled three of our cars with gas. I was concerned that supplies might be interrupted for a while, so I bought all I could - just like most of the people around me. The result was that most stations ran out of gas, which was potentially tragic for people that needed to evacuate. If the price had increased, I probably would have filled one of our vehicles and just relied on that.

The same is true for many items that we thought we might need. When they were available, we bought all that we thought we might need. Everyone here preaches that you need to fill your gas tanks, buy bottled water, stock up on batteries, etc when a storm is coming and so most of us "grab" what we can until the stores run out. If the stores could set market prices for these things, we'd all focus more on getting just what we really needed.

How is it that the same people that recognize that price controls are causing shortages in Venezuela think that the same thing isn't happening here?

Matt Chwalowski writes:

I agree 100% with David, Don and Mark Perry about the negative consequences of anti-price gauging laws. But why Attorney Generals, presumably open-minded and educated people, impose such laws with such negative consequences? Is it due to ideological bias, playing to economically illiterate citizens? Have you, David, discussed them with any AG in the country -- what did they tell you?

David Cantor writes:

I agree that very high prices likely increase the available supply of goods. It is a question of how much, though, in cases of natural disasters. The disruption to transportation networks is so severe, there may not be a way for even a very motivated seller to increase supply.

There is a further consequence to these very high prices. Matching supply and demand through high prices also means that scarce resources are preferentially allocated to the well-off. I find this morally repulsive.

Alan Goldhammer writes:

Some goods are easily replaced and price increases (I dislike the term gouging) will be quickly dealt with. However, others will take some time to deal with. Several hundred thousand cars were rendered useless by the flooding and must be replaced. For most of Houston there is no alternative transportation system than the automobile/pickup truck. Filling this void is not the same as delivering water or food to the area (or even building materials). This is the same point David Cantor raises in his post.

The ongoing story of how Houston rebuilds will be extremely interesting and I hope gets documented in terms of all the infrastructure issues.

Don Boudreaux writes:

David Cantor: Keep in mind that even the expectation of very high prices causes quantity supplied (and quantity demanded) responses before natural disasters strike. These responses, it can be argued plausibly, occur even for many disasters that strike without specific prior warning (such as earthquakes in California), but these responses without question occur for natural disasters, such as hurricanes and blizzards, for which their victims have prior warning.

Take hurricane Irma. Roads, bridges, and the electrical grid throughout Florida are today (September 6th) all fine. Irma is still hundreds of miles away from there. Yet the expectation of very high prices several days from now, immediately after Irma's anticipated landfall in south Florida, surely causes merchants to bring to south Florida many more supplies of bottled water, propane, and other such goods today - more supplies than they would have brought in today were no hurricane bearing down on that region. If Irma hits as anticipated, south Floridians will be supplied with staple goods better than they would be supplied were prices there not allowed to rise after the hurricane strikes.

(Also note that, if prices aren't allowed to rise, fewer merchants with available inventories will bother to open their stores after the storm. More merchants will remain at home with their families, not bothering to brave the downed power lines and obstructed roads to get to their stores. Relatedly, if prices aren't allowed to rise, merchants will, before the storm strikes, spend less time and fewer resources guarding their inventories against the prospect of being damaged by the storm.)

Importantly, prices in south Florida start to rise in anticipation of the hurricane even before it strikes. These price hikes not only further incite suppliers to bring more provisions to south Florida, they incite consumers to use supplies of those goods more sparingly - that is, more "efficiently" - than they would have used them were the prices not allowed to rise.

As for the rich having 'unfair' access to goods if the prices of those goods are allowed to rise to market-clearing levels, this possibility (which no one can deny) must be weighed against the fact that prohibiting price hikes almost certainly ensures that available supplies in the disaster regions are kept fewer than they would be absent the prohibition of price hikes.

But there's a relevant question here: how can you be sure that the well-off will not have even greater advantages over the not-well-off in acquiring goods that are in short supply because of the prohibition on price hikes? It's possible that an effective prohibition on price hikes will result in the poor getting a greater quantity of these goods than they'd get absent the prohibition, but arguments in favor of prohibitions on so-called "price gouging" typically merely assume that this outcome will arise. Yet the validity of this assumption can plausibly be questioned. Listed below are only some possibilities that opponents of "price gouging" too often fail to consider.

With prices kept by government dictate from rising...

... merchants hoard more of their inventories hoping to sell them at black-market prices, which will be even higher than prices would be were there there no government prohibition on price hikes;

... merchants give family and friends - and themselves - greater access to available supplies the prices of which are kept artificially low by the prohibition on "price gouging";

... merchants give political officials, business acquaintances, and celebrities greater access to available supplies the prices of which are kept artificially low by the prohibition on "price gouging";

... the poor, because their homes and vehicles suffer, on average, greater damage than is dealt to the homes and vehicles of the rich, are less able to get quickly to the front of the queues of consumers waiting to buy goods in short supply;

... the rich, anticipating the queues that will arise because of the prohibition on "price gouging," will hire people to rush to stores immediately after the storm passes in order to buy supplies for the rich; (and the amounts that the rich will thereby purchase are likely to be greater, because of the artificially low prices, than the rich would buy if prices were allowed to rise);

... the rich - again because their homes are less likely to be severely damaged by the storm than are the homes of the poor - simply won't need plywood and other building materials as desperately as will the poor;

... the rich, because they are more likely to have generators than are the poor - and to have more storage space (including refrigeration and freezer space) in their homes - will be better provisioned than the poor after the storm and, thus, will be less affected than the poor by any government-induced shortages of goods;

... compared to the poor, the rich will disproportionately evacuate from areas likely to be struck by a severe storm, leaving in the storm's aftermath disproportionately large numbers of the poor and non-rich competing for bottled water and other goods that are in short supply in the ravaged area.

Micke writes:

@Mark Barbieri: "How is it that the same people that recognize that price controls are causing shortages in Venezuela think that the same thing isn't happening here?"

You'd be surprised by the number of people who believe that the problems in Venezuela come from too much capitalism, not too little.

robc writes:
The disruption to transportation networks is so severe, there may not be a way for even a very motivated seller to increase supply.

If the profit is high enough, people will find ingenious ways. Look at the creativity shown by drug smugglers.

Trevor H writes:

I wonder how it would be perceived if a retailer put up this sign: "We have doubled prices to discourage hoarding. Please buy only what you need. All excess proceeds will be donated to Charity X."

And then follow-up a week or two after the storm with a picture of them handing a check to Charity X.

Roger McKinney writes:

Anger at price "gouging" is evidence of pure envy. Most people consider profits of any kind to be immoral and greater profits during a crisis to be the worst. People would be much happier with no products than with the idea that someone made "excessive" profits. Like the Russians have always said, we would rather all starve together than have our neighbor do better than us.

The Church theologians at the University of Salamanca, Spain debated price "gouging" in the 16th century and determined there was nothing immoral about it. They had decided that the just price was the one arrived at by feww negotiations between buyers and sellers without coercion. Even if the seller knew that more supplies were on the way he was under no obligation to reduce prices.

dave writes:

just a small, perhaps pedantic, point of fact: the piece is from Marketplace which is NOT an NPR program. Though, depending on what station you listen to, it probably comes on directly after an NPR news show like All Things Considered.

David R. Henderson writes:

@David Boaz and dave,
Thanks. Correction made.

gofx writes:

Right you are, Don Boudreaux in your response to David Cantor. I believe back in the 1970's John Denver was tired of waiting in gas lines so he bought the station!

Billy Kaubashine writes:

The entire airline fare system is built on varying degrees of gouging; they have turned it into a subtle art. However, news stories regarding air fares for Florida evacuees would suggest that the subtlety has gone out the window.

BC writes:

In addition to airlines, Uber also implements gouging ("surge pricing") without alienating customers so much that customers abandon them. Maybe, because Uber's surge pricing is systematic, pre-announced, and done regularly, it may seem less "exploitive" or opportunistic. Since Uber surge pricing is not a surprise, riders can try to plan around likely high-price periods, if possible. If it were common practice for gas stations, convenience stores, etc. to gouge, then
maybe consumers would learn to stock up ahead of time or develop other contingincies, thus alleviating the high demand during actual emergencies.

There has always been grumbling about Uber surge pricing but, by sticking with it, Uber has taught its customers to adapt to it.

David R Henderson writes:

Very good point. Thanks.


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