Anytime there is a storm or some other disaster I often hear the mention of price gouging. Whether discussed on the local news or Facebook comments, price gouging is almost always portrayed in a negative light.
What is Price Gouging?
Price gouging is when someone sells supplies such as food or gasoline in a disaster area at a significantly marked-up price. Those known to price gouge are often either businesses in the area of devastation or people that bring supplies from surrounding areas. Price gougers are known to charge as much as several hundred percent above regular market price: a price that people are willing to pay due to the shortage of these vital goods during emergencies.
Seems Pretty Messed Up
Price gouging is illegal in 35 states, and at the surface level this seems right; after all, isn’t it just plain wrong to charge people more for supplies when they need them the most? Yet when you look at the scenario through the lens of a traditional economics perspective, the situation is no longer so clear-cut.
What Do Most Economists Think?
Despite seeming unethical on the surface, many economists see price gouging as the most efficient way to get people the resources and supplies that they need. This reasoning can be explained best by the concept of the invisible hand, which was devised by economist Adam Smith and laid out in his book “The Wealth of Nations” in 1776. The term inviable hand was used by Adam Smith to illustrate the idea that the market allocates resources throughout the economy based on prices. For instance, anytime there is a shortage in supply, the result is a rise in the price people are willing to pay for that good. This rise in price then acts as an indicator to current and potential suppliers that there is increased profit potential for selling goods in that area, which acts to eliminate the shortage.
Scenario One: Zero Price Gougers
In order to see why price gouging laws are problematic, we must first look at this from the scenario in which zero price gougers enter the market. Even if store owners had stocked up enough supplies to sell during the disaster, people tend to buy more than they need in times of emergency because of the uncertainty involved. This fact of human nature makes a shortage in this situation very likely.
Little Incentive For Suppliers
Now if the prices are fixed to pre-disaster levels, then suppliers from surrounding areas have no economic incentive to incur the extra transportation costs associated with delivering their goods to the affected area. A similar lack of incentive can be seen for existing suppliers as well. For instance, if store owners knew that they would be able to sell goods at a marked-up price during emergencies, then they would have the incentive to incur the extra cost associated with holding those extra goods year-round.
What About the Government and Charities?
The lack of incentive for both current suppliers and new entrants to increase supply leaves the responsibility of providing these limited resources to the government and charities. The problem here is that the government has been known to be ineffective in these situations, and generous actors are great, but can’t always be counted on. I would be remiss not to mention that I do believe that government does have some role in recovery, but that role should be providing what the free market is unable to, rather than preventing and replacing the free market through laws. Although price gouging is illegal in most states, there will naturally be some active price gougers that no law will dissuade; and as you will see next, having a small handful of price gougers has a worse outcome for consumers than an abundance of them.
Scenario Two: Many Price Gougers
If all price gouging were legal then the price that people had to pay during emergencies would not be much more than the cost that they pay normally. However, because a handful of people do price gouge despite it being illegal, then there is ironically a shortage of price gougers. To illustrate this, imagine a town where there was a shortage of 100 generators. If only one price gouger entered the market he or she could charge almost as much as they wanted, let’s say $500 for a $100 generator. Now consider the situation where instead of one price gouger, there were five. What would result is more competition between the five suppliers and thus a slightly lower price, maybe $300 for the same $100 generators. Finally image a situation in which price gougers were actually encouraged, leading to 100 price gougers. This many new suppliers would essentially eliminate the shortage, resulting in a price close to pre-disaster levels, maybe $105. An abundance of price gougers in this scenario solves both the shortage issue that results from zero price gougers, as well as the extreme prices associated with a limited number of price gougers.
It Comes Down to a Choice
From an economics perspective, this leaves us with two options; I’ll leave it to you to decide what option you believe is best:
Option 1: During disasters, you don’t pay a price premium for supplies, but due to a shortage, some may not have access to those supplies.
OR
Option 2: During disasters, you pay a price premium for certain supplies, but everyone has access to those supplies.
There’s a Deeper Point Here
Although I think price gouging is an interesting and important topic, there is also a bigger picture idea that I am attempting to demonstrate here. When making decisions it is best to realize that the alternative you choose is rarely 100% good and conversely, the one you didn’t is rarely 100% bad.
With almost every decision there are pros and cons of each and it is important to acknowledge them rather than pretend they that they don’t exist. This may be a controversial example, but why can’t someone be pro-life but still consider the possibility that Rowe vs Wade has led to a decrease in crime? I propose a similar question regarding pro-choice: why can’t someone believe that abortion should be legal, and still admit that an embryo is essentially a life?
I don’t mention these two stances to imply that they are right or wrong, but rather to shed light on the reason why stances like these are so rare – People are often too uncomfortable with reality, so they see the world as they would like to see it rather than how it truly is.
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