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On "Price Gouging"

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dchernik Posted: Sun, Oct 14 2007 10:16 PM

Consider the practice of so-called "price gouging" during emergencies, when stores raise prices on items in their inventories. Economically, this has two aspects: static and dynamic. Statically, the higher prices serve to some extent to channel goods into the hands of those who value them most.

Suppose that as a result of a disaster the price of a certain can of soup has gone up from $2 to $6, and the price of chicken, from $1 to $7 per pound. Two persons decide how to spend their pennies. One considers the $6 soup to be too expensive, but he has great taste for chicken and is willing to pay the $7 for one pound of the bird. The other has the opposite preferences. Both individuals's desires can be satisfied. But if the prices had stayed the same, the first buyer might have bought the soup and the second buyer might have bought the chicken, despite the fact that in both cases the other would have paid much more. It is true that the producer surplus has increased at the expense of the consumer surplus, but the existing supply has nonetheless been economized and the most urgent consumer wants are found out and satisfied, albeit at a higher price, as they would not have been if the rise in prices had been outlawed.

Now it may, of course, be pointed out that people differ with respect to the utility they attach to money. Thus, a rich person might buy both the soup and the chicken, because of the low utility to him of the $13 that both cost together, thus preventing someone who "really needs" them from getting them. But the economizing effect is not neutralized. Indeed, if someone "really needed" something, he would have paid a premium for it. And our rich person presumably exchanged something of low value to him (the $13) for something of high value (the food). Thus, both a consumer was well served, and the producer received a high profit. What can possibly be wrong with that?

I am well aware that prices do not measure value. Prices are outcomes of ranking goods in various orders by persons participating in an exchange. But the fact that A was priced out of the market, while B was not, served to clear the market and equilibrate supply and demand. And that's no mean accomplishment. But am I right in arguing that the most value was created because of the rise in prices?

Second, there is the dynamic effect whereby the temporarily higher prices create opportunities for arbitrage. Entrepreneurs now have an incentive to buy low at places not affected by the disaster and ship goods quickly (before others do the same) into the disaster area and sell high there. This will cause supply to increase and will lower prices to their normal level in a matter of days. If, however, prices are prevented from rising, the existing inventories will be quickly wiped out, and many fewer or no new goods will be supplied.

These considerations show that it is uneconomic and destructive to prevent business owners from raising prices of their goods and services in disaster-affected areas. Then there is the simple moral reason to the effect that any store's goods are its property, and it is wrong to prevent people from voluntary contracting to exchange justly acquired property at mutually agreed prices. Let then there be no more talk of price controls, hatred of businessmen, and glorification of government interventionism in emergency situations.

Am I right in my analysis?

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xahrx replied on Mon, Oct 15 2007 10:45 AM

More or less, yes. The problem however is to convince people of this fact. The problem also is that in such situations the government will actively oppress attempts to ship goods into the affected areas. And, the government has actively been involved in the impoverishment of a good portion of the people who, when the shock of a disaster hits, sees the prices of the basics like food and water go through the roof which exposes the problems of living paycheck to paycheck on devalued nominal wages, and having your paper promises tied up in an electronic system that's been wiped out, essentially closing off access to your property when you need it the most.

Or, in other words, economic reality isn't going to necessarily sway the emotional response people have to disaster victims, and government is very skilled at hiding the role it has played in creating the disaster situation, and using the consequences of its own policies as the excuse for more intervention. Rationally one would wonder how people manage to live in areas which flood or are hit by massive storms, earthquakes, etc., regularly and yet they and their local governments still haven't managed to realize that a good stock of bottled water, nonperishable food, and an escape route are good ideas. I have all three laid up and planned out respectively here in the northeast, and I barely have to deal with anything except the occasional mild snow storm or flooded roads. To my mind it only goes to show how easily overlooked the effects of dependency on the government are.

"I was just in the bathroom getting ready to leave the house, if you must know, and a sudden wave of admiration for the cotton swab came over me." - Anonymous
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Inquisitor replied on Mon, Oct 15 2007 11:14 AM

Price gouging is merely a sophisticated form of rationing, in response to scarcity. Add in terms like 'profit', 'price' etc. though and you are likely to elicit the most irrational responses from most people, perhaps because they are not evolutionarily adapted to view price 'gouging' in the way they view rationing. I believe Walter Block might be doing an article on the matter.

 Good points btw Xahrx.


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DBratton replied on Mon, Oct 15 2007 11:17 AM

If, however, prices are prevented from rising, the existing inventories will be quickly wiped out, and many fewer or no new goods will be supplied.

I've lived in Houston 30 years and have been through a few hurricanes and many hurricane scares. There is an odd but regular pattern to gasoline supply shortages during these emergencies. Two days before the storm is due to hit all the stations will be sold out all over town. But the minute the wind dies down the local radio stations begin announcing a gas station open here and a gas station open there. They make a sort of game out of it by inviting listeners to call in and report open stations around town so that the station addresses can be reported on the air. Within four to six hours gas stations are usually open all over town.

Never once in 30 years have I ever heard anyone asked the obvious question - where did the gas come from? It was supposedly sold out and there is no way tankers have been around that fast. Because of the price gouging law station owners and employees have no incentive to stick around and keep their stations open. They have lives and property too and they usually just bug out when everybody else does.

So there is actually more harm done by the price gauging statute than the price fixing induced shortage that one would normally expect. The statute also induces a kind of passive hording by the sellers. Sellers don't care enough to stay in the market so they exit and a critical commodity goes unsold despite an urgent demand for it.

BTW Hurricane Rita was the worst I've ever seen. Houstonians usually hunker down for a storm but the pictures of the aftermath of Katrina had people spooked. Every freeway out of town was like a parking lot three days before the storm was due to hit. At the same time every morsel of food was gone from the stores and every gas station was closed. Afterwards it was reported by the local media that only about twenty percent of the people who wanted to leave got out. If there had been no price gouging law the price of gas might have soared to $15 or $20 per gallon, but there would have been gas. Most everyone wanting to leave would have been compelled to share rides because of the high price. And of course that in turn would have allowed more to get out.


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G8R HED replied on Tue, Oct 16 2007 1:48 PM

I think many people consider all prices - gouging or not - to be an issue of morality rather than economics.

Economics (to "them") is simply something the government does to make sure business is charging 'moral' prices.  

"Oh, I wish I could pray the way this dog looks at the meat" - Martin Luther

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Bostwick replied on Tue, Oct 16 2007 3:32 PM


Am I right in my analysis?




 It also discourages hordeing, the nightmare of socialists.


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