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Some Economics of ‘Price Gouging’

In my Principles of Microeconomics class at George Mason University, my students and I recently discussed the economics of so-called “price gouging” – the signifiant rise in the prices of staple goods (and services) following a natural disaster.  Basic supply-and-demand analysis explains quite well the observed pattern of price changes (prices rise sharply when a natural disaster strikes as demand rises and, at the same time, supply falls; and then prices eventually fall back to their pre-disaster levels as demand and supply both return to their pre-disaster levels).

The most popular alternative explanation – one heard repeatedly from the media, pundits, politicians, and, in general, people who are economically uninformed – is that the rise in prices is caused by greed (implying – although one never hears it said – that the subsequent fall in prices is caused by altruism).  As I’ve said elsewhere, “greed” is no more an acceptable explanation for “price gouging” than “gravity” is an acceptable explanation for plane crashes.  Causal factors far less constant and more variable than greed and gravity are at work in both cases and, hence, must be identified in order to explain the events.

Here’s an essay that I wrote ten years ago on this topic and that I assign each semester to my students.  A slice (where the example used is a government-imposed price ceiling on bottled water):

Fact one: capping the price does not keep the cost of bottled water low. Time spent waiting, time and fuel spent driving to distant towns where supplies are greater, and the anxiety unleashed by the inability to obtain water are all costs. The fact that these costs are not revealed in the price of bottled water does not render them less significant or real.

Fact two: while a higher market price both prompts consumers voluntarily to economize more diligently on water’s use and increases the quantity of water supplied (by giving incentives to suppliers to bring more water to this market), the queues and empty shelve

Fact three: the economization forced on consumers by price caps is ugly and arbitrary. Those obliged to do without are the unlucky ones who couldn’t get into the queue early enough and who have no political or business connections. These unlucky consumers are also typically too poor to pay the high prices demanded on the black market. A fact always missed by proponents of price caps is that black-market prices are higher than the unregulated market prices would be. The reason is that unregulated market prices—being visible and legal—will stimulate a larger inflow of supplies than will black-market prices.

There’s no denying that people dislike the higher prices. What is deniable is that the higher prices are the problem. They are not the problem; they reflect the problem. Because the problem itself is unfortunate, its undistorted reflection will reveal this misfortune. But only by revealing this misfortune as accurately as possible to everyone who can help to minimize its effects will reality be returned as quickly as possible to normal.

(Coincidentally, I learned just this morning that this 2005 essay of mine will be included in a new volume forthcoming from the Foundation for Economic Education – a volume entitled Cliches of Progressivism.)