As the coastal areas of the United States prepares for hurricane Isaac, I expect to read more stories claiming the ungodly practice of “price gouging”. That is, the practice of greedy businessmen taking advantage of people in times of crisis by raising prices on essentials as bottled water, food, gasoline, hotel rooms and so on. In two words: Horse hockey!
People who make such emotional claims do not understand the important function of the pricing mechanism in the economy to hinder the misuse of scarce resources. Prices are the market’s way to regulate the consumption of these resources. The alternative would be for government to pass a law or regulation or to physically intervene and ration these resources at a lower price. This only leads to more shortages as vendors aren’t able to raise the capital required to replace the resources that had been consumed. In times of shortages, not only do vendors sell products at higher prices but also their suppliers. Distortions in the information that prices provide for demand in a free market lead to distortions in supply. This is the key flaw in socialist societies. This is why Soviet countries had long bread lines. Generally, a black market begins as consumer’s demands are met by someone else who is able to sell the products at higher than regulated prices. This maintains supply.
Returning to our hurricane situation, we can see how this works in real time. That is, with real flesh and blood human beings. Let us suppose that Mr. and Mrs. Jones want to escape northward and plan on staying at a hotel for a few days while the storm blows over. It might take days before areas are reopened to home owners. They decide to stop by grandma’s house and take her along. We have Mr. and Mrs. Jones, their two kids and grandma heading north in the family grocery getter. They stop at a low cost hotel chain and decide to get three rooms for three days. It so happens that their state had passed “anti-price gouging laws” a few years earlier so they can be assured to get a cheap low rate for their rooms. Mr. and Mrs. Jones take one room with a king size bed, the two kids have another room with twin full size beds and grandma gets her smoking room with a queen size bed. Wonderful! This is almost like a mini vacation. Now, let us assume the Smith family, the White family, the O’Hara family, the Brown family, the Schmidt family and so on also need rooms. Alas, there is no room left at the inn. The well meaning government authorities saw to it with their anti-price gouging laws that supply was negatively affected. Had there never been any such laws then maybe the hotel management would have been able to adjust prices upward to slow consumption. Thus, Mr. and Mrs. Jones, having to pay higher rates, might have opted to put grandma in the same room with the kids and told her to smoke outside. This would free up a room for another family. Raise the prices even more and the whole Jones family might have to limit themselves to one room and have someone sleep on a roll away bed. Hence, even more supply.
This principle applies to every consumer product in crisis areas. Recently, I read an article denouncing the spike in gasoline prices as the storm draws nearer. This is an important way for more consumers to put some gasoline in their cars. They may not fill up but at least they can get up the road far enough away to get more gas at a lower price and complete their trip. Had the gas station been under an anti-price gouging law then fewer people would be able to get the gasoline as everyone will “fill ’er up. This results in leaving some behind to tough out the storm. This phenomenon is closely related to what is known as the “tragedy of the commons”. When property is held in “common” and not privatized, people tend to use or consume as much as they can before supply runs out. To see this in real time visit the free breakfast buffet the next morning at the hotel in our example.
Another negative of anti-price gouging laws are the effects on entrepreneurs taking on risk to re-supply devastated areas after a storm. The amount of risk and expense required to brave a trip into a devastated area is quite high. When entrepreneurs aren’t rewarded with the profit motive to enter these areas then the survivors suffer as supplies dwindle. It’s better to pay extra for bottled water than have none at all. I hear some argue that the government through FEMA will supply the survivors with water, food and shelter. That is a discomforting position to be in. Dependence on the government will eventually lead you to sit in your own excrement, beside a dead body in the Super Dome! This is the ultimate illustration in the failure of government dependency. How long will it take FEMA to get set up and begin supplying the area with necessities? One day? One week? Who determines how long these people have to go without before the government hands out the goodies. Is it not better, and cheaper, for entrepreneurs to use their own capital and perform this function and not depend on the tax supported inefficiencies that are inherent to government agencies?
Along with reports of price gouging I also like to look for stories from mainstream economists who will inevitably claim that the hurricane will lead to an economic boom. They falsely claim that the spending resulting from rebuilding will reinvigorate the economy in the devastated areas. It makes one wonder if any of these economists have ever once read Bastiat’s “Broken Window Fallacy”. Or, if they even understand it.
I’ll be writing on that one when it comes up.
3 thoughts on “The Fallacy of Price Gouging”
Great post. I enjoyed it. Have to look at the "seen and unseen" effects of intervention into the economy. Thanks!
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