In Praise of Price Gouging - Island of Sanity

Island of Sanity

Policy Issues

In Praise of Price Gouging

Whenever there's a crisis, there is a sharply increased demand for certain products. Some things that most people don't need under normal circumstances are suddenly needed, like portable electric generators and chain saws. And people start hoarding. As I write this, we are in the midst of the corona virus outbreak. (By the time you read this, it's probably over, and you know how things turned out. Regardless ...) During this outbreak, people started hoarding toilet paper and hand sanitizer.

Side note: Why hoard toilet paper? If this virus explodes and millions of people are dying in the streets and civilization totters on the brink of collapse, is your big concern going to be whether you have enough toilet paper? I can at least comprehend hoarding hand sanitizer: medical authorities have said that liberal use of hand sanitizer is an effective way to fight the spread of the disease. I could understand hoarding non-perhishable food and fuel. But ... toilet paper? But anyway ...

Some stores have responded to this by jacking up the price of toilet paper and hand sanitizer. And authorities routinely respond by declaring this "price gouging" and illegal.

But ... so-called price gouging serves two very useful economic purposes. This takes us back to one of the most basic, well-established laws of economics: supply and demand.

On the demand side, price gouging discourages hoarding while generally being only a minor inconvenience to people who buy reasonable quantities. In a crisis, we should want to discourage hoarding. It serves no socially useful purpose for one person to stockpile 200 rolls of toilet paper in his garage while others can't get any. So say toilet paper normally costs, what, about $1 a roll? So suppose that when people start hoarding, a store jacks the price up to $5 per roll. For someone using normal amounts, maybe one roll a week, this costs him an extra $4 per week. Annoying and inconvenient, but it's not going to bankrupt him. But for a hoarder who goes out and buys 200 rolls, this costs him $1000. That's a lot of money for most people. Some hoarders will no doubt bite the bullet and spend that much. But for many, that will be a strong disincentive to hoarding, and so they'll buy more reasonable quantities and leave some for others.

On the supply side, a steep rise in price gives manufacturers the incentive to produce more and the up-front cash to make it possible to ramp up production. They can divert production from other products that are not in such strong demand to produce the wanted product. They also have an influx of cash to enable them to increase capacity. They can buy more machines and buy the needed raw materials.

So price gouging gives consumers an incentive to buy reasonable quantities rather than hoarding, and at the same time it gives manufacturers the incentive and ability to produce more to meet this higher demand.

Similarly, when there is a natural disaster, like a flood or a tornado, people suddenly need things that they don't normally need, like electric generators and chain saws. And so some enterprising individual who has a supply of such equipment will load up a truck, drive to the disaster site, and sell it at inflated prices. And again, the government will step in and declare this price gouging and illegal.

So think about this for five seconds. Suppose that there is a flood in, say, Louisianna, and people there suddenly need electric generators. And suppose that someone owns a hardware store in Wisconsin and he has a supply of electric generators. If he normally sells these generators in Wisconsin for $1000 each but he figures out that he can sell them in Louisianna for $2000 each, he has a strong incentive to rent a big truck, load it up with a bunch of generators, hire someone to fill in at the store for him for a week or two, and haul these generators down to Louisianna and sell them to people who really need them. Everybody benefits: People at the disaster site get generators that they need, the store owner gets a bunch of money, and along the way the truck rental company gets some money and the person hired to fill in gets a job.

Now suppose that the government declares this illegal, and says that he cannot charge any more for generators that he sells in Louisianna than he charges for generators that he sells in Wisconsin. Does this mean that the hardware store owner will then bring a truckload of generators to Louisianna and sell them at the normal price? Almost certainly not. Why should he go to all the effort and expense of renting the truck and driving to Louisianna if he's going to get the same money that he would get in Wisconsin? I suppose he might do it anyway just because he's a nice guy and wants to help. But this kind of help costs him a lot of money -- the cost of renting the truck and taking time away from his regular job. He may not be able to afford it no matter how much he wishes he could.

The law protecting people from price gouging doesn't mean that they get the equipment they need at a lower price. It "protects" them from getting the equipment they need at all. And so the politicians pat themselves on the back for how they helped these poor people in need, while meanwhile the people they "helped" are freezing to death in the dark because the politicians prevented them from getting the electrical generators they needed.

Price gouging is not evil. It is a positive good. It should not be a crime. It should be, if not really praised, at least accepted as the realistic solution to the problem of how to direct resources to where they are needed most.

© 2020 by Jay Johansen


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