Price gouging, ethics, markets, and the corrupting influence of Econ 101

Michael Giberson

Last I checked, James Kwak had 147 comments on his blog post on price gouging and the corrupting influence of Econ 101. Other bloggers have jumped into the fray: Adam Ozimek at Modeled Behavior, the Undergraduate at Observations of a Naive Undergraduate, and David Beckworth at Macro and Other Market Musings.  Quite a firestorm of activity.

Kwak ignited this firestorm with commentary on Kahneman, Knetsch, and Thaler‘s classic question of the fairness of a snow shovel price increase the day after a snowstorm:

Today in class, the professor posed the first question from the paper:

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

In 1986, 82 percent of respondents thought this was unfair. In class, it was about 50-50.

As the professor said, this is probably because there are a lot of business school students in this class. Business school students are classic Econ 101 robots.

What follows, in the post and in the comments and the other blog responses, is a delightful jumble of conversations over morality and markets (and rich people vs. poor people and WWJD and shortages of organs for transplants and sudden needs for vaccines and free market ideology and zero-sum games and more, more, more).

Most of the analytical problems in the post and in the comments comes from assuming a fixed supply of snow shovels and a zero sum game, as if the hardware store (vaccine producers, organ donors and transplant facilities, etc.) had no past and no future.  Also, the moral analysis provided is lacking in subtlety.

So here is your test question:

Consider two hardware stores: one prices snow shovels at $15 when there is no snow and at $20 when there is snow; the other maintains a fixed price for snow shovels under both no-snow and snow conditions. In equilibrium, the second store will carry a smaller inventory than the first and offer it a price between $15 and $20. Which pricing policy is more moral?

(Yes, the problem is underspecified – so make any necessary assumptions about frequency of snowstorms, the distribution of income, desperately ill children, number of infirm widows living in the area, the costs of carrying inventory, etc. – that are relevant to your moral analysis and then get on with it. List your assumptions in your answer. Does it matter if the second store’s pricing policy is due to the owner’s preferences, due to the owner’s concern over patron reactions, or due to state law? Does it matter if the fixed price is closer to $15.01 or closer to $19.99? What if the fixed price were $25? Please note: your answer will fail to satisfy if it fails to address Zwolinski’s non-worseness analysis.)

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6 thoughts on “Price gouging, ethics, markets, and the corrupting influence of Econ 101

  1. The highest price is the most moral withing two weeks of a snow because snow creates a public good (daunting global warming; awesome particular sensitivity on this moral hazard, eh?) This changes if the road/walk/whatever material can stub in as reflective, unless it’s more scenic and better exercise with the snow.

    There is an inflection or three when there are 4 to 30 feet of snow. (Are the animal hoarders privately resourceful in these conditions? Alternately, under cover of snow, will they kennel, run and train them outdoors?)

    The experience of finding the stores have no shovels, leafblowers, pickaxes or other tunneling equipment, moreover, outweighs the minor gouge suggested. $80 shovels has been an observable gouge and $140 shovels (not even with maple hanging rings) a smite (though for $150 I was offered a story on why the shopkeeper disliked shovels, with a chance of a shovel.)

  2. “In this case, supply is fixed in the short term, so raising the price won’t increase supply; the Econ 101 argument is that raising the price allocates the shovels to people who will derive more utility from them (because they will pay more), thereby increasing social welfare.

    But this rests on a huge assumption: that willingness to pay is the same as utility. Unfortunately, however, this assumption fails in the real world; poor people simply can’t pay as much for snow shovels as rich people, and as a result a price increase will allocate shovels to rich people, not to those who need them the most.”

    I agree with this second paragraph. I think that many economists, including Austrian economists, forget that willingness-to-pay must be joined with ability-to-pay.

    I am not so sure about the supply of shovels in the short run (perhaps if the store can charge a higher price, the owner could dig up some old shovels from storage, etc), and I would also point out another huge assumption: that simply because the store owner *can* charge a higher price in that scenario, that he always *would* charge that higher price to every customer–including the old ladies and the infirm. Price discrimination works both ways – the freedom to charge whatever price one wants means that prices can be sliding scale. Thirdly, the poor may not always be excluded for another reason: the store owner could sell it to them on an installment plan (loan).

    The question is whether the freedom to charge higher prices will likely lead to a more efficient outcome even in the short term – or whether the emergency situation, which elevates the issue of the short term and diminishes the issue of longer term supply somewhat (but certainly not entirely – between snow storms, as pointed out, the ability to charge a higher price may induce greater supply for the upcoming storms) is enough to make free prices inefficient.

    Given the assumptions:
    (1) Freedom to charge any price will tend to increase supply and innovation at least between storms if not also during them.
    (2) The ability to price discriminate may allow the flexibility of a nice store owner to offer cheaper prices as well as higher prices when s/he deems it moral.

    I would argue that the flexible pricing solution is more moral.

  3. If you define morality as maximizing social welfare, then the price-gouging strategy is more moral since it is the one which allocates goods to those willing to pay the most.

    BTW, price gouging came up in my Micro class the other day. The professsor warned the class to be very careful with the word “need”. It has a connotation that suggests and absolute requirement rather than what it actually is – a relatively strong desire. Reading Zwolinski’s article, I was struck by the repeated use of the word “need” where “strongly desire” was, strictly speaking, more accurate. And what an emotional difference it makes when you make the substitution!

  4. I like the post. Thought provoking.

    I think I’ll consider going into the snow shovel rental business.

    BTW, I assume the idea of snow storms and snow shovels especially abstract for someone living in Texas. Would someone living in Minnesota have sytematically different responses than Texas residents?

  5. To Mike on “need”: I agree that “need” is a problem word – it implies the absence of any alternatives, and rarely are alternatives absent.

    To jwetmore: Interesting thought. I did live in the Washington DC area for 20 years and experienced regular winter snows, sometimes serious snow, but nothing like Minnesota (or New England, or Chicago, etc.). These past few years snow shovels and snow storms have become pleasantly abstract concepts. (Last winter I “shoveled” the heaviest snowstorm we had with a push broom. Not to effectively, but apparently the snow shovel was lost in the move.)

    But you have an interesting point. In some populations asking about snowstorms may emotionally charged the fairness/unfairness reactions of the survey participants in ways not controlled for by the study authors. But surely if Kahneman, Knesch and Thaler didn’t examine the point, somewhere in the volumes of literature that has followed someone would have thought of this, right? Worth a little digging, I think.

  6. I know there is a price at which the trade off between loss of good will to the seller is worth it to charge buyers. A better example is the one about the guy who filled his pickup truck up with generators and sold them for twice the price to storm victims who were very willing and thankful buyers trying to save their frozen food from spoilage. In both cases two parties, buyer and seller entered into free exchange in order to mutually benefit.

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