Price Gouging and Behavioral Economics – More Work Needed

Michael Giberson

I’ve been reading several price gouging articles lately. One, by G. C. Rapp in the Kentucky Law Journal, (“Gouging: Terrorist Attacks, Hurricanes, and the Legal and Economic Aspects of Post-Disaster Price Regulation”, 2006) makes a relatively novel reach to behavioral economics to try to justify an efficiency claim for anti-price gouging laws. In particular, Rapp claims an “availability heuristic” will lead merchants to raise prices too high after a disaster, because affected merchants will over-estimate the likelihood of a repeat disaster. An “anchoring heuristic” can then lead merchants to keep prices to be sticky at the higher level, Rapp said, even after the emergency is over.

Rapp said anti-gouging legislation, by preventing these behavioral biases from producing too-high prices, can help the market be more efficient. On first reading, the argument seemed almost entirely ad hoc and arbitrary. For example, why a story in which the availability bias strikes first, and then the anchoring bias comes second? Why doesn’t the “anchoring heuristic” overcome the “availability heuristic” in the first place, and keep prices sticky at the lower – and in Rapp’s view, more efficient – level?  About the best thing I can say about Rapp’s article is that he tries to find an efficiency benefit for anti-price gouging laws, which is more than can be said for most advocates of anti gouging policy.

Upon a little reflection it seems that an anchoring heuristic is playing an important role in price gouging, but not the role Rapp asserts.

Consider the first example provided in Kahneman, Knetsch, and Thaler, “Fairness as a Constraint on Profit Seeking: Entitlements in the Market,” (American Economic Review, 1986):

A hardware store has been selling snow shovels for $15. The morning after a large snowstorm, the store raises the price to $20.

Kahneman, et al., then asked respondents to rate the action as fair or unfair. In their survey 82 percent said it was unfair for the hardware store to raise the price in this situation.  The authors explain the sense of unfairness in relation to a “reference transaction” with typical or expected levels of price and profit.  The sense of unfairness diminishes if there is a cost-based reason for the increase in price.

But I think there is more than just this anchoring heuristic going on in this case. It isn’t just the price increase relative to a reference transaction, but a price increase during a period of presumed increased hardship – the “large snowstorm.” I’d bet if they posed this alternative version, they’d get a significantly different answer:

A hardware store has been selling snow shovels for $15. The morning after Memorial Day, the store raises the price to $20.

Or:

A hardware store has been selling snow shovels for $15. The morning after a new store manager arrives, the store raises the price to $20.

To me, these versions don’t seem to trigger a sense of unfairness. On this topic, I still think the Kling conjecture is right: price increases in times of increased hardship are perceived as morally wrong by some people (not merely unfair), because of an embedded moral principle that says it is wrong to take advantage of people in distress (and price increases on necessary items during times of hardship is seen as ‘taking advantage of people’ unless there is a cost basis for the increase).

Of course just because people (may) have an embedded moral principle that says price gouging is wrong doesn’t mean that anti-price gouging laws are necessarily right.  (It may not even mean that price gouging is wrong, but that raises questions to be addressed in a subsequent post.) Anti-price gouging laws limit economic freedom, hamper economic adjustment after market disruptions, discourage holding of precautionary inventories of useful items, and impedes the activities of persons who would otherwise seek to aid people harmed by disruptions. There are costs to indulging this moralizing impulse by turning it into law, and the question for students of public policy should be whether the benefits of anti-price gouging legislation can be expected to exceed the costs.

Rarely do public policy discussions of price gouging try to specify the nature of the benefits to be achieved by a ban, and at least Rapp’s article nods in this direction.

(FURTHER NOTE: David Skarbek critiques Rapp’s piece in an article in the Public Contract Law Journal, Market Failure and Natural Disasters: A Reexamination of Anti-Gouging Laws, 2007-2008. Skarbek picks on other problems in the Rapp article not discussed here – Rapp makes an odd attempt to justify anti-price gouging legislation on the grounds of a possibility of widespread electronic payments system failure – but parts of Skarbek’s counterarguments strike me as similarly ad hoc.)

Earlier posts on price gouging studies:

• Price gouging laws: emotions, economics, and policy
• Price gouging: At the intersection of emotions, ethics, and economics