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3 Good Things about "Price Gouging"

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Tags Bureaucracy and RegulationCalculation and KnowledgePrices

As so often happens in the wake of a natural disaster, government officials in Texas are currently investigating claims of “price gouging,” which the office of the Attorney General reminds residents is illegal after the governor declares a disaster. This is a classic example of the ostensible contrast between greed and altruism, capitalism and charity.

Economists who favor the free market know the standard arguments for letting the price skyrocket to “clear the market” when there are supply shortages and demand spikes. These are important arguments, and indeed I will review them below.

At the same time, I think in our zeal to lecture the public on the efficient allocation of resources, we economists often forget to stress an important aspect of private morality when disaster strikes. Specifically, if certain individuals experience a genuine “windfall gain” simply because they happen to be holding goods that suddenly become very scarce, then these individuals can donate their windfall to support relief efforts. In this way, there is no question of them profiting from their neighbors’ suffering. Market prices are still able to perform their valuable function of communicating information about supplies and demands to everyone in the system, while the losses imposed by nature are more evenly distributed because of charitable assistance given from the lucky to the unlucky.

The Standard Arguments for Letting Prices Clear the Market

After a natural disaster, the supplies of certain items — such as bottled water, gasoline, flashlights, and canned goods — become much more rigid, while the demand for these items goes through the roof. Consequently, the “market-clearing price,” at which the quantity supplied equals the quantity demanded, also may rise quite significantly. (There were reports of a convenience store in Houston charging $99 for a case of bottled water and $20 for a gallon of gasoline.)

It’s obvious why most people would find this outcome horrendous, and that government officials would reassure the public that such behavior won’t be tolerated.

Even so, free market economists stress the social benefits of allowing the price to rise in this scenario. We can break these benefits into those emanating from the supply side and those emanating from the demand side. (For an excellent discussion, listen to David R. Henderson’s recent appearance on the Tom Woods Show.)

Benefit 1: Calling in More Supplies 

On the supply side, a much higher price acts as a loudspeaker telling the rest of the world: “Houston wants a lot more bottled water and gasoline!” Even though we might casually say that after a natural disaster, the supply of these items is fixed, strictly speaking that isn’t correct. Except in the most outrageous circumstances (such as an avalanche or radiation leak), outsiders can bring in additional amounts of these precious items.

It’s certainly true that morality comes into play here. For example, a convenience store owner who lives only an hour from Houston, and who has a big van, might decide to cancel his golf plans to instead make a few trips to either donate or sell “at cost” whatever supplies he has, in order to do his part in relieving suffering. Most Americans would probably say that was “the right thing to do” for somebody who found himself in that situation, when the news reported just how bad the flooding was.

But what about a convenience store owner who lives six hours from Houston? Is it acceptable for him to charge a bit more than “cost” or even “normal retail price” in order to recoup some of the sacrifice he would have to make — not just counting the gas in his vehicle but also the opportunity cost of missing work — if he were to make one or more round trips?

As we change the circumstances, Americans would begin to disagree about the exact moral obligations of various people who happened to have access to much-needed goods. But we can certainly agree that in practice more people would end up deciding to help move water, gasoline, flashlights, and other items into Houston, the more we allowed them to charge for these items once they unloaded them in the beleaguered city.

Also keep in mind that this “upward sloping supply curve” — meaning that as the price rises, there are more units of bottled water (say) in Houston — doesn’t just operate geographically, but it also operates temporally.

Benefit 2: Storing Up Goods for Emergency Use 

For example, suppose the manager of a grocery store hears on the news that a hurricane is approaching. If she believes the authorities will let her charge whatever the market will bear, then she might decide to stock the warehouse with extra cases of water, flashlights, batteries, generators, etc. She knows that if the storm turns out to be a nothingburger, she will have to run a big sale the following week, in order to clear out the excess inventory. (After all, she presumably already had the optimal amount of inventory before the impending hurricane made her bulk up the warehouse.)

However, so long as our hypothetical grocery store manager knows she will be legally allowed to charge (say) quadruple the normal price in the event of flooding, then she will probably err on the side of loading up the warehouse with more units, compared to her decisions if she knows that the authorities will punish her for “gouging” her customers.

Similar reasoning holds for gas station owners, who might have the ability to load up on unusually large amounts of inventory — perhaps by having extra trucks come in, and remain on their property — but would only be willing to incur this extra expense, if they thought there were a possibility the market price of gasoline would break (say) $10 and that the authorities would allow them to charge such prices.

As these examples illustrate, the amount of bottled water, gasoline, batteries, etc. “on hand” in Houston when the hurricane struck is itself influenced by the attitude of the authorities toward “price gouging.” Business owners and pure speculators didn’t ship in as much of these goods as they would have done, in an environment in which voluntary transactions were sacrosanct legally.

In his interview with Tom Woods, Henderson also made a very subtle point about high prices inducing owners to carry goods forward in time. I’ll illustrate his point with a hypothetical story: In the current legal environment, with prohibitions against “gouging,” a Houston store owner sitting on a few pallets of bottled water would probably just unload them all on Day 1 and leave town, because there would be nothing else for him to do. However, if the authorities and the public didn’t condemn owners for charging the true market price, such a person might reason, “Right now bottled water is selling for $10 per case in this neighborhood. But if the rain doesn’t stop and it takes longer than people expect for the streets to clear, it’s entirely possible that I could hold back 50 of my remaining cases in the back storeroom, and then sell them for $50 each in a few days. The prospect of getting an extra $2000 totally makes it worth my while to sleep here in the store for a few days, rather than leaving Houston.”

This type of analysis shows that we want high prices not simply to tell businesses in Arkansas that they should sell some of their bottled water in Houston, rather than unloading it all in Little Rock, but also to tell businesses in Houston that they should sell some of their bottled water on Day 5 after the hurricane rather than unloading it all on Day 1.

Benefit 3: Encouraging Conservation 

In the previous section we outlined the social benefits of high prices coming from the increased quantity supplied of the crucial items. On the flip side, letting prices rise will also encourage conservation among the end users, so that any given supply of items is “rationed” among people more uniformly.

Consider bottled water. Once the storm hits and a particular family knows they will be stuck in Houston for several days with flooded streets, the first inclination might be to run to the store and stock up on needed items. At the normal retail price, a mother might buy 10 cases of bottled water, not only for drinking but also in case they need to use it for (say) boiling pasta. After all, who knows how long the utilities might be knocked out? She reasons that she can store the cases in her pantry and draw the water down over the next two months, if it turns out that things go back to normal sooner rather than later. There’s no harm in stocking way up on water, just in case.

But of course, this is exactly what we don’t want people to do, in a situation where there are only (say) 3 cases of bottled water per stranded family in the city. We want the people who hit the stores before their neighbors to be very judicious in how much they buy, because they need to leave other units on the shelves for the next families who show up.

This is exactly what an “unconscionable” price will do. If the store is charging $20 for a case of water that normally retails for $4, our hypothetical mother won’t so casually load 10 cases into her SUV. After that sticker shock, suddenly boiling pasta with bottled water won’t seem as appealing. Maybe she’ll only buy 3 cases of water, and get some cans of tuna fish and protein bars instead.

When it comes to gasoline, there is a particular perversity of anti-gouging rules in the case of an impending storm. Imagine yourself as a military commander, who has thousands of vehicles you need to move away from the coast, and you only have a limited amount of fuel on your coastal base. However, there are plenty of refueling depots a few hours inland. What do you do?

The obvious solution is to only allow your troops to put enough fuel in their vehicles to make it to the next refueling station. This spreads the available fuel around so that you can evacuate as many vehicles as possible.

Now back to the real world: In the path of an incoming storm, where thousands of people want to evacuate the coast, depending on refinery interruptions and other bottlenecks, it’s possible that some local stations will run out of gas if they don’t raise their prices significantly. The people who are lucky enough to get to the stations first will naturally fill the tank up, before getting on the interstate to get out of Dodge. Then the unlucky followers will see the gas station is empty, and may end up stalling on the interstate. The authorities then have a problem of dealing with stranded motorists who are stuck not because of flooding, but because they ran out of fuel during their escape.

In contrast, if the few relevant station owners charge $15 per gallon, then people who had (say) a half-tank in their car when the storm hit, will say, “That’s outrageous!” and get back on the highway, to see if prices are any better in another 50 miles. At a price of $15, only people who are about to run out of gas will buy any, and even they will only purchase enough to give them some breathing room. They too will probably take their chances and hope that gas is cheaper if they move away from the storm. Just as our hypothetical military commander, the decentralized price system allocates the scarce fuel among the vehicles to allow as many as possible to evacuate.

Is It Moral to Profit While Others Suffer?

Some people on social media heard these familiar economist arguments, but pushed back. “Yeah, we get your points about ‘efficiency,’” they said. “But let’s face it: During a disaster, plenty of heroes rise to the challenge, putting themselves in harm’s way in order to do what they can to help people in need. It is simply wrong for some convenience store owner who had just coincidentally gotten in a shipment of bottled water the day before, to effectively hit the lotto while his neighbors lose their house.”

I am sympathetic to this point, and I agree that typical libertarian economists often come across as coldhearted and seem detached from this everyday morality. (Indeed, this was the position I took in my concluding essay to the Independent Institute’s new book, Pope Francis and the Caring Society.)

Yet rather than prohibit owners from charging “what the market will bear,” I think a better way to avoid personally profiting from the tragedy of others is to suggest that they donate their genuine “windfalls” to relief efforts.

For example, consider a convenience store owner who happens to be sitting on 100 cases of bottled water that he normally sells for $4. (Assume he didn’t take any special measures to bulk up before the storm hit; this is the inventory he would have been holding in any case.) Because of the flooding, he realizes he could probably charge $14 and still sell out. So there is a potential $1,000 ( = $10 margin of “gouging” x 100 cases) in pure windfall profit he could make.

The conventional moralists would say no, he should keep his price at $4. But they have in mind that he would otherwise take that $1,000 and pocket it.

Suppose instead, however, that the owner charges the full $14, but then donates his $1,000 windfall to a local relief effort that is handing out free packets of food and dry clothes to families who were flooded out of their homes and have literally nothing (including wallets). Or to make the point even more clearly, suppose he donates the $1,000 windfall to a local organization that uses the money to buy bottled water and hand it out to desperate people?

Once we go down this path, we see that the insistence on charging only $4 for the cases of water really just means that our hypothetical store owner is concentrating his $1,000 worth of charity on the particular Houstonians who happen to walk into his store and pull out their credit card to make a big purchase. What are the odds that these people are the ones in Houston most in need of his implicit $1,000 charitable donation that day?

Conclusion

As economists in the Austrian tradition stress more than others, market prices act as signals that allow humans to communicate valuable information with each other. Just as it would stymie relief efforts if rescue workers couldn’t use cell phones or walkie talkies in a disaster area, by the same token government officials hamper humanity’s ability to recover from a crisis when they prohibit market prices from letting producers and consumers talk to each other.

Robert P. Murphy is a Senior Fellow with the Mises Institute and Research Assistant Professor with the Free Market Institute at Texas Tech University. He is the author of many books including Choice: Cooperation, Enterprise, and Human Action (Independent Institute, 2015) which is a modern distillation of the essentials of Mises's thought for the layperson. Murphy is co-host, with Tom Woods, of the popular podcast Contra Krugman, which is a weekly refutation of Paul Krugman's New York Times column.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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