The Myth of Price Gouging
Every time a hurricane rolls around, I hear something on the radio like this:
Governor Bush has declared a state of emergency in the areas affected by the hurricane, which has activated anti-price-gouging laws, protecting consumers from high prices.
The stupidity of that statement is palpable. “Protecting consumers from high prices.”? As if prices are something that businesses can just choose to raise on a whim, or that high prices are a bad thing. False. Prices go up because of supply and demand, and they are a good thing, because they relieve stresses on the marketplace and lead to new methods of delivery for desiring consumers and a natural rationing of supplies according to need. Now I know there are some of you out there who are objecting, so I’m going to give you several easy-to-understand examples. Lay down the hammer and sickle for a minute and listen.
Let’s say Homestead, FL is in the path of a hurricane. Let’s say that they have about 7 days of warning (rare for a hurricane that you get that much advance notice). Businesses, anticipating high demand, increase their supplies of bottled water. Sure enough, before the hurricane hits, and after, demand for bottled water goes up, matching the increase in supply. If the increase in supply exactly matches the increase in demand, prices will stay the same. Now, say that ABC Bottled Water, a convenience store in Homestead, decides to raise their prices from $1.00 a bottle to $3.00 a bottle. (I’m using whole numbers here, so just try to pretend that $1.00 a bottle is a normal price.) What happens then? Simple: people don’t buy water there. They can get it down the street for $1.00 a bottle. Now, what if many businesses try to raise prices to $3.00 a bottle all at once? Well, first off, every single business needs to do so, or people will just go to the places that didn’t. Getting businesses to independently inflate prices at the same time without an appropriate market force is highly improbable. But we’ll suspend disbelief for a moment and pretend that it happens. Now what? Well, water is $3.00 a bottle everywhere. At $3.00 a bottle, demand drops, rather precipitously. As a result, no one is selling much water. “Well this stinks,” the owner of ABC Bottled Water thinks to himself. “We have all this water, and people want it, but it’s too expensive! We could lower our prices to $1.50 and we’d sell much more water.” So he lowers his prices. And guess what… business spikes. No one is buying $3.00 bottles of water anymore, they’re all coming to ABC. “He’s taking all our customers!” the other store owners cry, and guess what… they lower their prices to match. Now, prices are all at $1.50, and a modest amount of people are buying water. “You know what,” thinks the owner of ABC to himself, “I could get even more customers if I dropped my prices to $1.25 a bottle.” And so he does. And so his competitors follow suit. In the end, the price will fall to where the supply and demand curves intersect… the market equilibrium price for bottled water. “Price gouging” in this case has failed.
Now, let’s say that Naples, FL didn’t know the hurricane was coming towards them, and only had 6 hours of warning. Businesses wouldn’t be able to anticipate the spikes in demand, and would thus be understocked. Let’s take a look at gasoline prices. Pretend the normal price for gasoline is $2.00 (you wish, eh?) The hurricane rolls through Naples, and the highways are blocked with downed trees and light poles. Tanker trunks won’t be able to make it to town for 5 days. Demand for gas will be high. People will need to power their generators and power their chainsaws and power their pickup trucks. Supply of gas is dwindling, because the tanker trucks cannot get through. Demand up, supply down, the market reacts, and prices go up. Say gas goes up to $5.00 a gallon. “That’s an outrage!” you say. “I wouldn’t pay it!” Fine. So don’t pay it. If enough people think like you prices will come down. But I’m guessing that at $4.00 a gallon, many of you would be willing to pay it. If you’re willing to pay it, you should be happy that prices have gone up, because otherwise, you would probably be unable to get any gas! If prices stay the same, supply is dwindling, and demand goes up… the gasoline will be gone in mere hours. Everyone will go fill up whether they need to or not. But this is not how the market works. If there is a stress on the market, the market needs to react.
The concern over “price gouging” isn’t anything of the sort. It is a concern over that fact that when supply is down and demand is up, prices go up to compensate. That’s not gouging, that’s a natural market reaction. It ensures that the people who don’t need gas don’t buy all of it, leaving none for those who really need it. Those who advocate anti-price-gouging laws are ensuring shortages of goods. They get people to support it by lying to them and making them believe that big evil businesses will make their prices higher just because there has been a natural disaster. This is not true. If there is adequate supply, prices will not go up at all. Actually, if there is oversupply, prices could go down.
