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Price Gouging

November 8, 2012

There is a shortage of gas in New York because, and only because, of anti-price gouging laws. If you want the shortage to go away, abolish the law and tomorrow there will be plenty of gas. Let’s break this down using supply and demand.

Supply: It is more expensive to deliver goods on a bright sunny day, or into a hurricane devastated area? Higher costs shift the supply curve left, increasing price.

Demand: During a hurricane, do people want gas, bottled water, and canned foods more, or less than they do in normal times? Obviously, demand goes up, and by quite a bit. The demand curve shifts right, which increases price.

Both supply and demand are pushing prices higher, and not because of “greed”, just for simple “econ 101” reasons. Price is not just a cost to consumers, it also provides compensation for suppliers. Even from a moral perspective, it is not fair to expect suppliers to face higher costs and not to pass at least some of those costs on to consumers. People who protest higher prices are being selfish and unreasonable. Throwing a tantrum at the laws of economics does not help.

Do Anti-Gouging Laws Help?
Let’s assume an anti-gouging law could be well enforced and the government doesn’t care about shortages. Will an anti-gouging law raise, or lower prices? At first glance, we would assume that anti-gouging laws would lower prices, since they mandate lower prices. However, in a crisis, the stockpiles of various supplies will run out very quickly at the pre-hurricane prices and firms have no incentive to resupply their stores, since they can’t make a profit at the pre-crisis prices. When customers try to get what little supplies legitimate firms do have, they will face long lines, fixed quantity rationing and other forms or non-pecuniary costs. Hordes of smugglers take the place of normal companies, selling at radically higher prices, instead of the slightly higher prices a reputation constrained firm would have. Not only do smugglers have to face the higher costs of the hurricane, but they also have fewer economies of scale and the costs of avoiding law enforcement, which they will happily pass on to their customers.

It is simply implausible that in the absence of anti-gouging laws, legitimate firms would let their competitors make huge profits selling at highly inflated prices. Competition would force prices down to marginal cost, just like it normally does in the market. It’s just that marginal costs during hurricanes are higher than they are without hurricanes. Private companies do an amazing job moving goods around the country to fulfill their customers’ demands, and emergency demands are no exception. Walmart outperformed FEMA dramatically in the aftermath of Katrina. Given a 20-30% premium over their normal prices, firms would rush to make a profit and keep the store shelves full. With anti-gouging laws, people are stuck paying a 300% premium to some shady guy on Craigslist.

Inelastic Supply?
Some have argued that in a disaster, the supply is inelastic and so the price mechanism does not increase supply to match demand. Therefore, price changes only affect the distribution of the surplus, not the total amount. That is simply not true. Maybe if Sandy were the first hurricane humanity had ever faced and firms had no idea that a price gouging law would be enforced, you could argue that supply was inelatic, but that’s not the situation we are in. Hurricanes happen several times a year. Firms are well aware of the law governing various parts of the country. If you think for a second that Exxon doesn’t know that New York has anti-gouging laws, you are out of your mind. Stockpiling goods prior to a storm is costly, and so firms are only going to do it if they can make a profit by doing so. In the absence of gouging laws, firms would store more goods prior to the hurricane and spend more shipping supplies into distressed areas. Currently, what are the incentives when a storm is approaching? Every gallon of gas you sell post-disaster is going to cost you money, so you let the tanks run dry. You don’t restock your warehouses. You let your employees take some leave. Disasters are a repeated game, and firms know the rules. You let them make a normal profit, and they’ll go the extra mile. You force them to take losses on every sale, and they’ll close up shop, and New York is watching that happen right now.

Further Reading
Prices are even more important after disasters
Rationing and Prices

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