Thomas Sowell on price gouging

Michael Giberson

An excerpt from a Thomas Sowell column on price gouging:

Charges of “price gouging” usually arise when prices are significantly higher than what people have been used to….

This raises questions that go to the heart of economics: What are prices for? What role do they play in the economy?

Prices are not just arbitrary numbers plucked out of the air. Nor are the price levels that you happen to be used to any more special or “fair” than other prices that are higher or lower.

What do prices do? They not only allow sellers to recover their costs, they force buyers to restrict how much they demand. More generally, prices cause goods and the resources that produce goods to flow in one direction through the economy rather than in a different direction.

How do “price gouging” and laws against it fit into this?

When either supply or demand changes, prices change. When the law prevents this, as with Florida’s anti-price-gouging laws, that reduces the flow of resources to where they would be most in demand. At the same time, price control reduces the need for the consumer to limit his demands on existing goods and resources….

Among the complaints in Florida is that hotels have raised their prices. One hotel whose rooms normally cost $40 a night now charged $109 a night and another hotel whose rooms likewise normally cost $40 a night now charged $160 a night.

Those who are long on indignation and short on economics may say that these hotels were now “charging all that the traffic will bear.” But they were probably charging all that the traffic would bear when such hotels were charging $40 a night.

The real question is: Why will the traffic bear more now? Obviously because supply and demand have both changed. Since both homes and hotels have been damaged or destroyed by the hurricanes, there are now more people seeking more rooms from fewer hotels.

What if prices were frozen where they were before all this happened?

Those who got to the hotel first would fill up the rooms and those who got there later would be out of luck — and perhaps out of doors or out of the community. At higher prices, a family that might have rented one room for the parents and another for the children will now double up in just one room because of the “exorbitant” prices. That leaves another room for someone else.

Someone whose home was damaged, but not destroyed, may decide to stay home and make do in less than ideal conditions, rather than pay the higher prices at the local hotel. That too will leave another room for someone whose home was damaged worse or destroyed.

In short, the new prices make as much economic sense under the new conditions as the old prices made under the old conditions.

It is essentially the same story when stores are selling ice, plywood, gasoline, or other things for prices that reflect today’s supply and demand, rather than yesterday’s supply and demand.

As it happens, Sowell’s column was first published in September 2004, after Hurricanes Charley and Frances had struck Florida. It applies as well today in New Jersey and New York.

If you’d like a second opinion, check out Steve Horwitz’s piece at the Institute of Economic Affairs blog: “Why prices should be allowed to rise after a disaster.”

ADDED: And in other news, “Gas Shortage Persists In New York, New Jersey, Contrary To Promises From Officials.”

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3 thoughts on “Thomas Sowell on price gouging

  1. Thomas Sowell’s comments are timeless.

    In her November 3 post, econgirl – http://www.economistsdoitwithmodels.com/, suggested that some sort of sharing of excess profits might be an answer for the fairness/ethics considerations regarding price gouging. Her exact words were:

    “I’d like to think that I’m not totally being unreasonable here, so I will throw the fairness police a bone and suggest that a better policy would involve some sharing of the excess profits between the gas stations and rescue organizations or something like that.”

    Given that the combination of state and federal taxes on corporate profits are approximately 40% in most locations, our current tax policies already provide significant sharing of “excess” profits.

    Are there other arrangements that can be made to allow price signals to efficiently guide production and consumption in times of shortages without eliciting outrage from individuals anchored to old prices?

    Would a “Windfall Profits” tax (that was not an excise tax) be socially acceptable? It would sure seem more efficient and equitable than shortages and politically determined allocations. And it would seem fairer than fines for individuals trying to satisfy customers at added expense. The rich would certainly pay more taxes in such a system, even if that payment was somewhat indirect.

  2. “Windfall profit”, like “price gouging”, is a term which defies specific numerical definition. Therefore, as with “price gouging”, its definition is subject to the whims of politicians and incitement by the press and activist groups. That is a prescription for chaos.

    Any attempt to “punish” entrepreneurs for the increased profits they realize as a result of the incremental risks they take would almost surely result in both higher prices and lower supply.

    Which is more important, in the overall scheme of things, price or product?

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