Disasters, Price Gouging, Greed, Ignorance, and Stupidity

You can bet on this fact: that occasionally there will be natural disasters like floods, fires, and earthquakes. You can also bet on a follow-on fact: that in those places, prices of essential goods and services will go up. And finally you can bet your life on this: that popular accusations of price gouging by greedy corporations and windfall profits will motivate politicians and bureaucrats to impose price controls.

Of all the harm that a natural disaster brings in its wake, one of the most harmful and the most avoidable is the deliberate, the imposition of price controls. It’s entirely human-caused. There is no justification. The move to control prices is based on ignorance of reality, a desire to do good, to signal a virtuous concern for the plight of the poor. It is wrongheaded and outright evil in its consequences.

Every disaster brings out the usual suspects who recycle the economic arguments against price controls. It’s hard to keep coming up with new and innovative ways to explain basic concepts of economics. But they do try.

Here’s a bit from the NY Times almost a year ago. Dateline: Sept 11, 2017. Hurricane price gouging is despicable. It starts:

When a devastating hurricane like Irma or Harvey arrives, stories about price gouging inevitably spread quickly. Last week, a one-way coach flight from Miami to Phoenix jumped in price from $547.50 to $3,258.50, prompting immediate outrage. In Houston, a picture of a case of water being sold for $42.96 at Best Buy did the same. (Best Buy apologized and said it was a “big mistake” by a few employees.)

Over all, more than 8,000 complaints of price gouging on items like gas, food and ice were lodged with the Florida attorney general’s office through the weekend.

On its face, the very idea of price gouging, especially during a natural disaster, feels outrageous. Indeed, 34 states have anti-gouging laws meant to protect consumers.

However, in a small slice of the world of economists and businesses, there is a fascinating debate about the topic — with many arguing that price gouging is actually a good thing.

Why is it a good thing that the price of the flight mentioned above rose six times the pre-disaster price? Why did the case of water cost a fortune? Is it simple greed or is there a reason?

Plain decency and intuition says making profiting from misery is morally wrong. But actually it’s the outrage against those high prices that is wrong and damaging. Our intuition is very, very wrong. It’s naive and divorced from reality.

To understand we have to understand what a market is and what its essential function is. Markets, through the price mechanism, convey information to buyers and sellers. That information is essential to know what to do.

The price signals to sellers how much stuff they have to bring to the market, and to buyers whether or not they need to economize. When potential sellers recognize an opportunity to make a profit and they enter the market. That increases the amount available and consequently moderates the price. The buyers see the higher than normal prices and tighten their belts. That reduces the quantities they consume.

Price controls destroy the information channels that people depend on to tell them what to do. They tell sellers that they will be foolish to supply their products at the controlled price. And they tell consumers that they don’t need to modify their consumption decisions. That leads to shortages of goods in the market.

Then there is the matter of fixed supplies. At any moment, at any place, there is only a fixed amount available for consumption. The supply is said to be “inelastic” — you cannot expand the supply however much you wish you could.

The number of airline seats is fixed in the short run (by definition.) If today 200 people want to travel from A to B but the airlines have only 100 seats to sell, everyone cannot be accommodated. No one has empty planes sitting around to meet unexpected demand. We have to “ration” out the available 100 seats,. It can be done in a variety of ways. One, a lottery system. Two, people in positions of authority choose who gets to travel. Three, let the market ration the seats by allowing the price to rise to the level at which there will be only 100 people willing to pay for the seats.

Yeah but that means the seats will be taken by the rich and the powerful. Yes, that’s the reality. There is no way that the number of seats can be expanded to meet the demand. The seats will go to those who are willing to pay the higher price, or to those who have special political privileges. You can address the problem through the market (voluntary transactions) or through political means (which means coercion and force.)

Price controls basically means that sellers are discouraged from entering the market. Take the airline example. Airlines don’t cover their costs in every flight. On average their try to cover their costs. They lose money during the lean seasons because they cannot fill all the seats that they need to have for the peak seasons. During the peak seasons, they fill the seats and at a higher price for each seat. That gives them the headroom to be able to stay in business by riding out the lean season losses.

If the airlines were not allowed to raise their prices during the peak seasons, they would have to fly fewer seats round the year so that they fill all seats during the lean and peak periods. Fewer seats means fewer seats for people. The fact that the prices are stable throughout the year is no good thing. Prices should fluctuate to approach some optimal outcome.

Why shouldn’t the government regulate prices? Simple reason: the government officials don’t have a clue about costs and prices. If they had they would be running businesses. Furthermore, they don’t have an incentive to remedy their cluelessness. They don’t have any skin in the game. The airlines people lose money if they are clueless and the market weeds out the ignorant and the incompetent. People in business have something to lose.

Government officials face perverse incentives. Not only they don’t pay a price for their misguided policies that are supposedly for the poor, they are rewarded for proposing idiotic policies by the people who are actually hurt by those same policies. It’s a perfect storm of idiocy and ignorance.

I wish we the people get into the habit of pausing every now and then, especially when we feel an outrage coming on, and ponder two simple questions:

  • If we believe this particular fact about the world to be true, what other facts must be true about the world?
  • If we do what’s being proposed, what else would happen other than what we are attempting to accomplish?

So if we believe that price controls are good for the poor, what other fact have to be true about the world? Do we see those things in the world? If not, perhaps we are mistaken about the goodness of price controls.

And if we do impose price controls, what are the consequences that must follow, other than preventing the price increase? Lazily assuming that nothing else changes is being full retard. Never go full retard.

It’s all karma, neh?

Author: Atanu Dey

Economist.

11 thoughts on “Disasters, Price Gouging, Greed, Ignorance, and Stupidity”

  2. I am full retard. I don’t understand why curbing price gouging during disasters is bad because it violates free market economics. What is fundamentally wrong having a few inefficiencies so our sense of outrage is eased based on simple intuition, even if it leads to bad second order effects (I am aware of the slippery slope). Why is a completely free market the optimal or ideal society to live in?

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    1. There is something called a market. It’s where trades takes place. All voluntary trades lead to benefits to trading parties. A free market is one in which there are no barriers to entry and exit. OK, so far?

      A free market is the best that one can do given all the other bits. What other bits? The people, their material assets, their skills, etc. A free market implements a process that determines prices. Think of the market as the hardware that runs a program; the output of the program is a list of prices. Each individual trade (that is, ever exchange) is a small nudge that changes the price of what’s traded, the aggregate of which is the free market price. That price is optimal in the sense that you cannot improve on the situation. If you try to establish a price that is not the free-market determined price, you make the system worse off.

      That is why you should never go full retard.

      BTW, what is called “price-gouging” is actually a good thing. It helps people out. Think about it.

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  3. There is a commodity, A, that becomes a must-have to everyone who cannot evacuate during a natural disaster. During normal times, the selling price of A and the profit that accrues to the seller is determined by free market dynamics. In a small window of time that covers a place threatened by a natural disaster, due to supply chain constraints, inventory of A is very limited compared to the demand. Since it is so much dearer during the natural disaster (that is transient), jacking up the price would cause those who are the most desperate and wealthy to be able to afford it. If the price remained the same, the inventory would be exhausted through a first come, first served basis.

    If price gouging is disallowed, the seller’s profit during the natural disaster is constrained to be the same as during normal times, up until there is inventory. In the period after the inventory has exhausted and until normalcy, the seller’s business suffers in general due to the disruption of business as usual and restricted demand for other items he sells, as well as the interrupted supply of stuff that he normally sells. His profit is hurt, and the price gouging restriction did not allow for any sort of compensation for the abnormal (but transient) business situation he finds himself in.

    The “bad” that has happened in the system as far as I can tell – forcing of a first-come, first-serve model for the few who can load up on the must-have commodity during this brief period, compared to a free market model. Restricting the profit of the sellers of that commodity and not allowing them to compensate somewhat for the restricted business activity that affects their business during the disaster. Is this terrible or ‘non-optimal’ during an abnormal situation? Am I neglecting other unintended consequences?

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    1. Namami, you are not considering the response of consumer and the supplier to the price. If the price is low, then the demand will be high and the supply lower than it would be at a higher price; if the price is high, the demand will be low and the supply will be higher than at a lower price.

      People are rational. At a low price, people stock up knowing that at the lower price, there will be a shortage. So not only “first come, first served” but “first come, take as much as you can carry away” will be the response of the consumer. And the supplier will stop supplying at the low price because their costs are higher than during normal conditions.

      Wealthy people in any case can get what they want by buying it at a higher price in the black market. Regardless of what the price control does to the supply side, the demand of the wealthy will be met. It’s the poor who suffer because they cannot get what they want at any price.

      If the price is allowed to rise to the point that the demand is met by sufficient supply (which will be higher due to higher prices), then there will be no shortage. Why? Because people economize when they face higher prices. And the higher prices means that you do not stock up. Why don’t you stock up? Because there will always be a supply at higher prices. No point in buying at the current high prices, only to see that the price come down when the emergency is over.

      This is counter-intuitive. But if you think it through, you realize that forcing a price on the market (instead of allowing the market to determine the price) is counter-productive. Many instances of counter-intuitive results are known, many of which are related to price controls. Rent control is one of them; and so are minimum wage laws. They do immense and evident harm; their supporters are always ignorant and sometimes well-meaning.

      In free markets (where there is no compulsion in either entering or exiting the market) the price informs all participants, the buyers and sellers, to alter their plans. It tells sellers, “Do bring stuff to the market” or “Do not bring stuff to this market”, and to the buyers, “Go buy a lot” or “Go buy only a limited quantity”. Prices convey extremely critical information to all; destroying that mechanism is willful idiocy

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    2. jacking up the price would cause those who are the most desperate and wealthy to be able to afford it.

      If you think it more deeply you will realize that when prices are controlled rich people will buy lot more creating a shortage for poor. Also, the seller might not take any risks to increase his inventory because there is simply no higher profit to be made.

      I am reminded of a personal incident. While hiking in Himalayas for 7 days we were roughly gaining 2000 feet a day. At the end of the each day a local man would use a risky shortcut to reach our night camp in evening, take all our phones, go down to his village, charge them up and arrive back to the camp next day early morning.

      Note that he would make the same climb in few hours where it took us several days because he used very very risk path. However his price also increased with the day. First he charged Rs 10 and by the time were were around 12000 feet he was charging Rs 50.

      The bigger surprise was at 14000 feet where in cave surrounded by nothing but snow another guy offered hot tea and Maggy noodles at Rs 100 per plate and Rs 50 per tea. He had traveled with several huge bags and had camped in the cave for several days. While many of use would have happily consumed 2 plates the prices forced us to share. Thus everyone had access to more food per person.

      If government forces a shopkeeper to sell biscuits at MRP during a disaster a well off man will buy all the packets, eat some and feed some to this dog. If the prices are determined by market well off people will be forced to buy less thus leaving more for others.

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  4. Thanks for your explanation.

    I think I understand your larger point. I am still not convinced that the effects will be as you suggest. Hoarding can be prevented by the stores enforcing a policy that there is a limit per customer. If a further explanation is provided that prices are being frozen and not jacked up and to respect more people getting essential supplies with limited inventory, I think many, in non-dysfunctional societies, will comply. I have seen pictures of signs in large grocery stores in coastal Florida (who do not increase their prices for the remaining inventory) and enforce purchase limits on customers when there is a dangerous hurricane brewing with evacuation orders. Of course, that situation can be gamed, but I suspect those gaming it are a few. My assumed scenario is a really exceptional situation with most people evacuating but some who just can’t, and a dire situation on the ground with a few forced to stay. There is typically no (or highly limited) supply into the area at such a time because of the exceptional circumstances. The supply is often the result of humanitarian considerations rather than pure business reasons. I don’t think there is a thriving black market during these scenarios. Those with a lot of means are usually the first to evacuate.

    Btw, I am a fan of Trader Joe’s (the grocery chain) and Costco (discount warehouse). They both carry great niche stuff for occasions, like, say, Thanksgiving that their clients look forward to. They have a very loyal customer base who know their products extremely well and look forward to purchasing these popular niche items. Typically, per customer limits are imposed on them. In fact in Costco, it is common to see a per customer limits when there is a pricing special with a deep discount on a product. Invariably, the seasoned store staff will tell you to buy before it runs out and that’s exactly what happens. Neither of these stores jack up the price knowing that demand will far outstrip supply. I wonder why. The only explanation I can think of is not worrying about the short-term profit and ensuring as many of their customer base gets in on the deal. I see the same dynamic at play in my disaster evacuation scenario. Good will and perceived fairness goes further at maximizing profits in the long run. (I am well aware that the price controls here are not imposed but an unconstrained business decision of the management).

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    1. I come to the basic question, what is jacking up price? What kind of emergency we are talking about? If jacking up is asking full price (I usually get a loaf of bread for $1, but when snow is forecast I may have to pay full price of $2.) I don’t mind. Even two times the usual full price I can understand. Jacking up 10x is another matter. Also life sustaining items, OTC medicines and bread and milk and TP are different. Thanks.

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