At Fiscal Times, economist Mark Thoma discusses price gouging and fairness and capitalism. I hoped Thoma had provided the thoughtful defense of price gouging restrictions that John Carney was looking for. Thoma didn’t really–he had a weightier topic in mind and price gouging was just a lever he used to pry open the issue. But he covers enough on price gouging to be worth taking a look at.
With long gas lines and other shortages putting people on edge in the wake of Hurricane Sandy, the usual post-disaster debate over the economics and ethics of price-gouging is underway…
Thoma explains the usual economist’s views: extraordinary prices can motivate extraordinary supply efforts and help allocate goods efficiently, though he omits the demand side rationing benefits usually part of this explanation. Then, allowing the efficiency gains, Thoma wonders why merchants usually don’t raise prices a lot, and why we have laws against efficient responses.
Most of the explanations economists have come up with rely upon the idea of fairness. After a natural disaster, people consider food, water, even goods like gasoline a necessity, and despite attempts by economists to explain that allowing prices to rise is best, they are sensitive to two types of inequities.
First, after a disaster supplies are short, shopping around may be next to impossible, and consumers do not appreciate producers exploiting short-term monopoly power. That’s especially true when they can’t see any obvious way for the higher prices to induce more supply in a reasonable time-frame due to the post-disaster conditions. If consumers feel they are being taken advantage of at a time when they already have enough problems due to the disaster, they might decide to shop elsewhere and this could hurt future sales to the extent that firms will forego price increases.
Second, people do not consider it fair when only the wealthy can get the things they need to ease their troubles. If people have to go without because of an act of god, then everyone should share in the pain. The wealthy should not be able to corner the available supplies of goods and services that are in high demand because of the disaster.
The essay then takes this fairness issue, suggests its importance beyond emergency conditions, and concludes that the endurance of capitalism depends on institutional changes that return us to a less uneven distribution of income. Okay, maybe, but I’ll stick to commenting only on the two price gouging points.
First, it surely seems true that “consumers do not appreciate producers exploiting short-term monopoly power,” the classic citation on this issue being Kahneman, Knetsch, and Thaler, “Fairness as a constraint on profit-seeking,” American Economic Review, 1986. (KKR) Merchants, understanding this aspect of consumer behavior, often fail to raise prices to market clearing levels and shortages and queues are common results.
Of course the thoughtful economic commentator has a response: Not every consumer reacts in this same way. After all, even in the two Canadian cities that KKR surveyed by telephone for the classic article, not everyone thought it unfair of a hardware store to raise the price of snow shovels the morning after a snowstorm. And social welfare would be improved if people were more willing to allow merchants to adjust prices freely after storms.
Second, “people do not consider it fair when only the wealthy can get the things they need … everyone should share in the pain.” The idea that freely adjusting prices will mean “only the wealthy can get the things they need” is obviously rhetorical excess. The U.S. economy is mostly a place where most prices freely move almost all of the time, and yet non-wealthy people get many of the things they need every day.
Even after natural disasters, an amazing number of non-wealthy people manage to survive. Neither Maryland nor Delaware have price gouging laws, did anyone notice the wealthy snapping up all of the gasoline, canned tuna, and bottled water in those states?
And by the way, it turns out that letting prices adjust helps achieve the result that more people share in the pain. Laws prohibiting price gouging tend to keep the pain localized to just where the natural disaster struck. If the price of gasoline in northern New Jersey had shot up by one or two dollars a gallon for a few days, gasoline trucks and rail cars around the middle Atlantic states and the Northeast would have been diverted to the area. Supplies would have flowed into stations in the affected areas that had power, consumers would have eased up on their hoarding and lines would have dwindled. And, and this is the “share the pain” result that Thoma (and Michael Sandel) find important, gasoline prices around the region would have risen in response to the supply shifts.
As it happened, gasoline prices in New Jersey rose an average of about 10 cents a gallon statewide after the storm, but that wasn’t enough to motivate extraordinary responses. Notice in this chart that gasoline prices in Philadelphia (in Pennsylvania but just across the river from New Jersey) resemble prices in Pittsburgh (in Pennsylvania but 300 miles to the west), but usually Philadelphia prices share the same market twists and turns as nearby New Jersey. Whatever happened at the end of September had Philly sharing the pain with New Jerseyans. Superstorm Sandy, on the other hand, with anti-price gouging laws prominently on display courtesy of Gov. Chris Christie, saw no sharing of the pain across the river.
The “sharing the pain” issue is examined in Montgomery, Baron, and Weisskopf, “Potential Effects of Proposed Price Gouging Legislation on the Cost and Severity of Gasoline Supply Interruptions,” Journal of Competition Law & Economics, 2007. They estimated that a federal price gouging law would have reduced the flow of goods into areas directly hit by Hurricanes Rita and Katrina and thereby left people there worse off, relatively speaking, and people elsewhere with more stuff.
Yes, maybe people would have their fairness-feelings hurt if prices rose in disaster-struck areas, but just maybe the efficiency gains (i.e., harm more effectively reduced in disaster-struck areas) are worth bruising a few feelings.
[Note: Edited for a few grammatical problems after initial post.-MG]