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Wednesday, June 5, 2013

"Price Gouging": Both Sides Get It Wrong

I was reading my facebook feed recently and someone mentioned something about how firms that price gouge (like gas stations) are shameful, etc. etc. etc.  This reminded me that the topic is one of my favorite microeconomics topics.  So I thought I'd write about it.  Price gouging is defined differently by the various State laws covering the term, but generally it is a situation in which a firm raises prices of a necessity good(s) (like gasoline) during a short-term shock (emergency - like a weather disaster) that is not easily justified by the cost of producing or exchanging said good.

To most conservatives or economists the very term "price gouging" is misleading and far from being a 'bad' thing, it is a necessary component to capitalism.   IE, it's just supply and demand.   When a hurricane hits, supply of gasoline falls, demand rises, so profit-maximizing firms raise their prices.   It's not outside of supply and demand - it IS supply and demand.  [the example/link given by the way is just an example and is not what I would technically define as a true price gouging situation unless you view bullets to be a necessity ;)]

Nevertheless, laws were put in place to protect consumers: to block price increases for situations when otherwise prices would increase based on reasons that cannot be explained by supply.  In other words - to prevent firms from increasing prices based on a demand spike (caused by people trying to flee a disaster).   The intentions are obvious and mostly on moral grounds.   The idea is that people are already suffering enough, it is not right to hit them financially during these times in life.

Consumerists have it correct that there is something morally amiss about jacking up prices during emergencies on necessity goods.  But their solutions are inelegant and target the wrong problem: unfairly targeting businesses.   Essentially they are telling profit-maximizing firms to temporarily stop profit-maximizing and to somehow only increase prices based on supply and not demand pressures, as if that is a simple napkin calculation during such times.   And if they don't comply, they could be fined.

Conservatives/Economists have it correct that it is all just supply and demand but they err in assuming that 'efficiency' (as defined in economics) is something society values or should value in time of emergency.   Consider an emergency where everyone is trying to fill up their tanks to leave the site.  The 'efficient' way to allocate resources is via the price mechanism - using supply and demand.   In other words 'price gouging' is efficient.  But the problem there (or at least a problem) is that only the well off are then able to flee, leaving the poorer members of society to suffer.   The rich full up their tanks and the top 5% flees while the 95% dies.  Whereas, in a disaster, sometimes it makes more sense to ration or do something less 'efficient' to ensure safety and fairness.   (So instead of the rich filling up, everyone fills up just enough to escape).  Demand, remember, is about the willingness AND ability to buy a good.   In other words, efficiency is not always welfare-enhancing or moral.

But here is why both groups, the conservatives/economists and the consumerists talk past each other.  In short, they both are correct, but missing the main problem.  The main problem is that we, as a society, don't like capitalism in all situations.  We particularly don't like it during emergencies.  (And many of us don't like it with regards to necessity goods in general - think health care).  But instead of altering our system to accommodate such emergencies (or even attempting to do so) we just pass these laws that essentially tell businesses to stop being themselves for some undefined amount of time.    In other words, price 'gouging' is not the problem, it is a necessary effect of capitalism.  The problem is that we chose to ignore that fact.

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