TCS Daily


Three Cheers for "Price Gougers"

By Rand Simberg - September 2, 2005 12:00 AM

With every disaster or crisis, it seems that the public, press and politicians require a remedial course in Economics 101. In fact, apparently we need an ongoing educational campaign even when there is no catastrophe, as demonstrated by the recent foolish legislation in the state of Hawaii to cap wholesale fuel prices. Note the subhead in the linked story: "Some analysts warn move may spur supply problems."

Really? Only "some"? Maybe they need to be more careful about which "analysts" they listen to. Whatever would we do without those other "analysts"?

 

Imagine the headlines, "Legislature Mandates Pi To Equal 3.00000 -- Some Analysts Warn Move May Spur Engineering Problems," or "King Canute Commands Tide To Recede -- Some Analysts Warn Move May Spur Wet Footwear Problems." What would we think of the analysts who thought that the proposed mandates were no problem, perfectly in consonance with the laws of physics and human nature? Even most people with typical journalism educations would recognize such heads and subheads as the jokes they are, but somehow when it comes to basic economics, the laws of supply and demand, and the function of prices in a market economy bizarrely remain subjects for public debate.

 

I write this little essay sadly, knowing that it's been written many times before, and that it will have to be written many times again, if history is any judge. It's hard enough to watch all of the suffering of these apocalyptic events on the Gulf Coast without having to contemplate as well the compounding of the problems that will be achieved in future days by editorial writers and public officials with their calls for defiance of economic reality. I grind my teeth in frustration at all of the economic damage that will continue to be wrought by well-meaning but economically ignorant people as they attempt to circumvent the most efficient means of delivering products and services to those areas in which they are needed most -- the market, with its pricing mechanisms.

 

Let's recap, briefly, for those who never took the class, or have forgotten it. It's really simple. In any locality, when the supply of a particular item is reduced with no change in demand, or the demand for it increased with no change in supply, or supply is decreased with a demand increase, prices will go up.

 

This is a signal to the market. To those demanding the product, it is a signal that the supply is relatively short, and that they should perhaps rethink the level of their demand, if possible. To the suppliers, it is a signal that more of the resources must be brought to market. In both cases, it will result in a change in behavior on both parties that will restore the balance between supply and demand. Moreover, it does so in a useful, quantitative way. It tells the supplier how much expense, risk and effort she should expend to increase the supply. This calculation may even bring new suppliers into the market. It also indicates the degree to which it is sensible for the consumer to change their demand. When by fiat we pretend that the price has not gone up, it's like covering up the signposts, and we shouldn't be surprised when those supplying no longer attempt to increase the supply, and those demanding can't be bothered to reduce their usage of that particular commodity.

 

What does this mean in the current situation?

 

Let us ignore for the moment the horrific situation in the worst-hit areas, in which first-worlders have been thrust into the third world literally overnight, many with no place to even sleep, let alone have access to food, water and other necessities or money with which to purchase them. In some of the other areas, homes are damaged, but intact and dry, and people have cash. Commodities like gasoline, perishable food and ice are in short supply. In fact, gasoline prices are rising across the nation, in response to the sudden reduction in refinery capacity on the Gulf Coast.

 

Consider -- if a gas station owner has gas, someone has to decide who gets it. If the price remains at pre-hurricane levels, many will fill their tanks, because they can afford to do so, against the chance (and even likelihood) that gas will later become completely unavailable (a self-fulfilling prophecy if the price is not allowed to rise). Many will do so even if they have no immediate need for it. But after the first few people do this, the gas will be gone, and none will be available for those who come after, because it's now tied up in the gas tanks of those who didn't really need it. Those who didn't get any may include emergency workers, or truck drivers who need it to go out and find other goods to bring in. It is likely worth more to them, but they didn't get it, because the price was artificially fixed. Moreover, had the price been allowed to rise, they would have been able to afford it, because they would have been able to demand more resources with which to pay for it -- the emergency worker might have had aid from local agencies to pay for it, or the truck driver might have been willing to make the investment in order to recover it by bringing in necessary goods (assuming, of course, that prices on those weren't capped).

 

Similarly, if ice prices rise to the market, the man who needs to keep his insulin cold for his diabetes treatment will place a higher value on it than the man who wants to keep his beer cold, and will have a better chance of getting it. The man who might rent two hotel rooms for his family for additional comfort might, in the face of appropriately higher prices, inconvenience himself and only get one, releasing one for another whole family.

 

This works for the supply side as well. Making and transporting ice costs money. When the local ice plant is out of commission, it has to be brought in from other locations, in refrigerated trucks, at higher gasoline costs. Who would bother to take the trouble, expense and risk to deliver it at a loss when they can only get the same price for it as before the hurricane?

 

Of course, some argue that prices shouldn't go up for stock on hand because the cost didn't go up. After all, the gas station owner is selling gas that he already paid for at pre-hurricane wholesale prices. Why should he make "obscene profits," taking advantage of a situation by jacking up the price when his price hasn't changed? But in reality his prices have already changed. He will have to replace the gas that he sells, and he knows, either indirectly because he understands the supply situation, or directly because he's gotten a call from his supplier, that the cost of his next tank load will be dramatically higher. In order to pay for it, he has to get as much as possible for the stock he has on hand, which means as much as the market will bear against his competition, if he has any. If he doesn't have any, then he just has to guess.

 

But won't some people make "unfair" profits from such "greed"?

 

Sure. Sometimes life isn't fair. We can't eliminate unfairness from life -- at best we can minimize it. But what's more unfair -- someone who supplies a community with needed goods while making a profit (at some financial, and even personal risk, given the breakdown of civil law in many areas, in which shipments can be hijacked), or someone who overpurchases and hoards a commodity because the price doesn't reflect the demand and supply? Ice at three dollars a bag doesn't do one much good if there are no bags available at that price.

 

The response to this, in turn, is that the solution is rationing. But is it more fair to have a bureaucrat, perhaps unfamiliar with the needs of the local community, making decisions about who should get scarce goods? Does the local commissar understand the market better than the market? We can recognize that when prices are high, some people of modest means may not get essential goods. A better solution for this is not to subsidize prices, which misallocate the resources due to the false market signals, but to subsidize the individuals who need help, by giving them cash or vouchers (somewhat akin to the food stamp program).

 

Price "gouging" is purely in the mind of the beholder, and there's no way to distinguish between it and the necessary signals that the market must have to ensure the most efficient use of resources. The price "gougers" are (often, if not always) the people who will have incentives to satisfy market needs as quickly as possible, and ensure that the economic recovery will occur. That some people may "unfairly" take advantage of this is a price we have to pay, and it's a small one compared to the alternative.

 

There has been much discussion recently (much of it foolish) of how this disaster was a result of "fooling mother nature," whether in the absurdity of asking whether or not it's a result of not acquiescing to the unjustifiable damage to our economy that would have resulted from the Kyoto Treaty, to the more sensible questions of how much effort we should expend to continue to divert the natural course of the greatest river on our continent. To whatever degree that's true, let us not compound the damage, and slow the recovery from it, by attempting to fool mother economics.

 

Rand Simberg is a consultant and entrepreneur in commercial space, space tourism, and internet security. He publishes a weblog, Transterrestrial Musings.

 

For more coverage of Hurricane Katrina and its aftermath, and to learn how you can help the victims of this disaster, please visit our special section Tragedy on the Gulf Coast. 

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