TCS Daily

Gouging? No Such Thing

By Iain Murray - September 18, 2005 12:00 AM

For various reasons, I took a lot of trips to the local hardware store on Sunday. On my route there were two gas stations gazing at each other across the thoroughfare. On the first trip, I noticed that one was charging $3.41 a gallon for regular, while the other was charging $3.29. And there, in a nutshell, was proof that gas price "gouging" does not exist.

This was actually an excellent case study for the basic economic lesson on supply and demand in situations of scarcity. Price is not an arbitrary figure. It contains a vast amount of information from the viewpoints of both the supplier and the customer. In normal circumstances it represents a balance between the effort and risk undertaken by the supplier to provide the product and the preferences and needs of the potential consumer taken in aggregate. Each individual consumer will have different preferences and needs, so that one may balk at a price another finds perfectly reasonable and another considers a bargain, but as a whole the price represents a signal about the balance of considerations among consumers in the market for the product.

When the product becomes scarce, however, additional information is added in the form of increased price that represents notice from the producer to the consumer that he may not be able to supply every customer with the full amount of the product desired. The customer is then more able to balance his wants with his needs and, again taken in aggregate, the market will respond to the scarcity by reducing its demand to meet the expected supply.

Rather than "gouging" members of the public, gas station owners are actually helping them by raising prices. This may seem counter-intuitive, but we have to consider how supply, demand and price interact. Normally, supply and demand dictate price, as is the case when gas prices spike. When price, however, is fixed, as would be the case if an "anti-gouging" law was in effect, then demand will outstrip the supply available. Shortage is the inevitable result. Gas would be rationed in some way, whether it is by some arbitrary legal fiat or by long lines at the pump. A black market is also more likely.

Moreover, as experience with rent control has shown, capping prices in times of scarcity also has the perverse effect of reducing the quantity of the good or service supplied. In other words, capping gas prices would actually lead to less gas being sold, as suppliers reduce the amount they are willing to sell in order to avoid loss. Shortages are therefore exacerbated. By contrast, anyone who tries "gouging" will find themselves with unsold supply and will be forced to lower their prices to offload it.

Nor is it gouging to raise your prices sharply in expectation that the next delivery is going to cost a lot more or not arrive at all. Lots of gas stations don't have supply contracts with suppliers, but have to pay cash to get the next delivery. So if the next tank truck is going to cost twice as much as the last one, the gas station owner has to put up his prices now in order to pay for the next delivery. If the next delivery is going to be delayed for a week or two or three, then the owner needs as a matter of the common good to raise his prices sharply immediately in order to signal to consumers that they need to cut back their consumption immediately.

Gouging in the gas market makes no sense. The owner of the station that was charging $3.41 as I drove by was presumably reacting to his own supply constraints. Yet because the other station took a lot of his business, those constraints eased. By the third time I drove past the station, he had reduced his price to $3.29 also.

Ah, but what of the hotel owner who has a captive market? Surely they are gouging people when they increase their rates when evacuees show up? Again, the higher price actually helps people. The evacuee is generally willing to pay more for overnight accommodation than the casual traveler because the evacuee has fewer options. Therefore, a higher price actually deters those who don't really need the rooms in favor of those who do. The result is more rooms available for those who really need them. (Hotel rooms, of course, are not the answer to a medium-to-long term crisis in shelter availability, from either the evacuee's or the hotel owner's point of view).

So, economics tells us that "gouging" simply doesn't exist in a rational market. Responsible higher prices actually ensure that as much of the good or service as possible is available for use. In an emergency, that is an important consideration.

Yet there is an unfortunate tendency in the free-market community to buy into the alarmist rhetoric that suggests "gouging" does go on. When the President declared on September 1st that he would take a zero-tolerance approach to price-gouging, he unwittingly perpetuated a myth. Buying into the rhetoric of gouging validates what Prof. David Henderson calls "do-it-yourself economics." Worse than that, however, it victimizes responsible suppliers who are doing their best to ensure the maximization of supply.

To see more of the extensive coverage of Hurricane Katrina from TCS, click here.

Price gouging is one of the great myths of our time. Because it doesn't exist, one should be wary of the motives of anyone who claims it does.


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