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Price Gouging: It's Not About Economics

In the aftermath of Hurricane Charley comes the inevitable clash over "price gouging". Florida's Attorney General Charlie Crist complained:

Hurricane Charley is the worst natural disaster to befall our state in a dozen years, and it is unthinkable that anyone would try to take advantage of neighbors at a time like this.

I found a brief description of the Florida price gouging statute on the Attorney General's site:

Florida's price gouging statute requires that the cost of necessities like food, water and shelter must remain at the price that was average during the 30 days immediately preceding a major storm like Hurricane Charley. Violations of the price gouging statute are subject to civil penalties of $1,000 per violation up to a total of $25,000 for multiple violations committed in a single 24-hour period. Florida's Deceptive and Unfair Trade Practices Act provides for civil penalties of $10,000 per violation or $15,000 for violations that victimize a senior citizen or handicapped person…

Laws against price gouging are politically, not economically, motivated.

The economic case in favor of price gouging is simple, compelling, and noncontroversial among economists. Indeed, after the hurricane many economists have written about the subject. Some consider it a teaching moment.

It isn't. Not at the economic level. I'll demonstrate this by briefly giving the economic case for price gouging, and then explain why the argument is unlikely to win anyone over.

"Price gouging" increases the availability of goods and services following a disaster. The ability to charge higher prices makes additional sources of supplies affordable. For example, food and construction workers from nearby unaffected areas will stream into the disaster zone because they command a higher price there than in their original areas. This effect is called arbitrage, and is distinct from (and in addition to) charitable donations.

  …more supplies is a good outcome, right?

Hurricanes can be predicted well enough that the affected area is likely to be known in advance. This makes it possible to stockpile some kinds of goods. Stockpiling has the benefit of making important goods immediately available in quantity at the site of the disaster. For an area to stockpile some good represents a significant increase over its typical demand; this strains the supply chain and increases costs. Thus, stockpiling is only economically feasible if those increased costs will be met by increased revenues from selling the stockpile after the disaster. If firms cannot raise their prices after the disaster (i.e. "price gouge"), they will not stockpile before it.

  …more supplies is a good outcome, right?

People will work longer hours if they're compensated with higher wages. Some people may charitably donate their extra time, but the rest require more money to overcome the disutility of labor. If the wage was right, people would be eager to work 10-, 12-, 14-hour or longer days. If laws prevent the payment of these higher wages, those extra potential hours worked are lost. It takes longer to repair the damage, with people inconvenienced in the meantime.

  …faster repairs is a good outcome, right?

"Price gouging" results in a better allocation of goods and services, because the alternative is shortages. Laws against price gouging are a form of price control, a price ceiling, and any price ceiling below the market-clearing rate creates a shortage. In an unhampered market, goods are available to whoever is willing and able to pay. In a shortage, allocation is haphazard, with goods going to people who show up first, or wait in line, or have influential friends, or they may be rationed, or many other possibilities.

The unhampered market lets people communicate the urgency of their need with dollars. The most important (i.e. valuable) uses for those goods will offer the highest prices for them, bidding them away from less important uses. If potable water is scarce and therefore more expensive, water for drinking will outbid water for decorative fountains. If prices were unchanged, there would be a shortage, and while this case is intentionally so clear-cut that almost any government allocation scheme would work, most cases are not so obvious: How much water for bathing versus irrigation? The market can answer that question — do you believe the government can?

  …you want goods to go toward their most urgent uses, right?

Okay, that wasn't as brief as I hoped, but it gives us more than enough to work with.

Nearly all economists believe the above arguments. They're in textbooks. If you tell an economist they're wrong, they'll look at you as if you've just told them water flows uphill or that the earth is flat.

Most laypeople think ill of price gouging, as evidenced by the popularity of politicians who rail against it. Simple ignorance of economics may explain a great part of this, but what's particularly interesting is the large class of people who are confronted by the economic arguments yet remain unpersuaded by them. My point is this: they don't believe the economic arguments are wrong, they believe they're irrelevant. And that's why no amount of economic instruction will win them over.

After a disaster, there is severe hardship. Homes have been destroyed, daily routines disrupted, and loss of life. There has been widespread and expensive property loss, and due to "price gouging" they'll have to pay even more to get their lives back to normal. In plain language, it doesn't feel right that things that are so important to so many people are so expensive. When something doesn't feel right, people look for a reason — and they identify the proximate cause, the merchants and laborers who have raised their prices. "They're profiting from my hardship! How dare they!"

The physical reality of disaster recovery is that things have been destroyed and it takes time and resources to recover. It is physically impossible to satisfy everyone's wants immediately after a disaster. That option isn't on the table. There aren't enough resources to go around. The market impact is that the things that are "so important to so many people" are expensive precisely because they're so important to so many people.

I used a phrase earlier when describing market allocation: "goods are available to whoever is willing and able to pay." This is what upsets people. Ability to pay has no relationship with need. The rich are able to outbid the poor. A poor person must spend a huge part of their income or savings (or go into debt) in order to compete with the rich. Or, they must wait until prices come back down.

This seems ethically wrong to most people because they link need with desert. This is standard altruism. Need is the source of desert. A person's need creates an ethical obligation to help them.

But whether a person is rich or poor doesn't affect their needs. People are usually considered equal, so that if a fixed amount of resources could repair one rich person's home or the homes of two poor people, it is the poor people who should get the resources. For allocating based on dollars instead of people, the market fails, by this understanding of ethics.

In addition to favoring the rich, "price gouging" is observed to increase the hardship of already-suffering people — first their homes are destroyed, then their bank accounts, too! This is reflexively viewed as people being taken advantage of by profiteering merchants. The Florida Attorney General described it as "trying to take advantage of neighbors" above. Again there is an issue of desert involved. The merchants are viewed as receiving a windfall profit they have not earned. For adding insult to injury and giving wealth to the undeserving, the market fails, by this understanding of ethics.

It is of little benefit to respond that market allocation of goods is better than government allocation, or that prices are merely a reflection of utility, or that higher prices bring about an increased supply. These things are true, but not persuasive.

The anti-capitalist mentality is rooted in altruist ethics, not in a lack of understanding of economics. Capitalism and altruism are fundamentally incompatible. Most people, faced with the choice, pick altruism. They will not be persuaded by economic arguments, because economics is derivative of politics and ethics, not the other way around.

I am not an altruist, which I believe more than any other single factor is responsible for my radical procapitalist positions.

Tiny Island