Nova workboard

a blog from young economists at Nova SBE

Is Price Gouging Really that Bad?

When a natural disaster occurs, the toll in lives and human welfare can be devastating. It’s natural for people to create institutions to curb suffering as much as possible under terrible circumstances. One of the policies implemented by many state governments across the U.S. are anti-price gouging laws. These laws vary from state to state, but what most do is prevent sellers from raising the price of certain goods during an emergency, such as a natural disaster. While the intentions of lawmakers and the majority of the voting public may be in the right place, these laws have a detrimental effect on the welfare of the people affected by natural disasters.

The intuition that most people have in response to sellers raising prices during an emergency is to denounce such businessmen as evil or greedy people taking advantage of the situation. While they may be greedy, the reality is that anti-price gouging laws function as a price ceiling. Because these laws prevent prices from rising above a certain point, they prevent the market from equilibrating when there is high demand or low supply due to an emergency. Thus they create shortages and prevent entrepreneurs from rectifying the situation through arbitrage.

Lets say a power outage has hit the state of Virginia during a heat wave. All surrounding states are left unaffected. Electric generators are in short supply, not because their supply has been reduced, but because the demand for generating power (for cooling, refrigeration, etc.) has increased, shifting the demand curve to the right.

What results is a higher equilibrium price. In the absence of anti-price gouging laws, sellers would demand a high price, say triple the original price for electric generators. While this may seem exorbitant, it would reflect the increased scarcity of generators and other goods relative to consumer demand. Residents of neighboring states may hear about the high prices these items fetch in Virginia and, in an effort to make a healthy profit, bring in these supplies from outside the state. They buy generators at a low price and sell them at a higher price in Virginia. Because sellers must undercut each other, over time these entrepreneurs must sell at lower and lower prices driving the equilibrium price lower and lower.

Under price gouging laws, these entrepreneurs would be arrested. Sellers would be forced to charge pre-emergency prices for these goods, and because the equilibrium price is above the price ceiling set by the state, a shortage would occur. Those who end up buying the goods will be those who arrive first, not the customers who most value the items.

Proponents of such laws may be concerned about the equality of populations affected by disaster, thinking that without government intervention only the rich could afford important supplies. These laws however create a similar situation to the launch of a popular product like the iPhone. Distribution wont be equitable or go where it’s most valued, but arbitrarily, to those who come first.

What price gouging laws do is intensify and prolong shortages during emergencies. It further hurts the victims of natural disasters and make them dependant on government aid, which perhaps is the effect desired by proponents.  

 

Further Reading

The Problem with Price Gouging Laws. Michael Giberson. Texas Tech University. Cato. 2011. http://object.cato.org/sites/cato.org/files/serials/files/regulation/2011/4/regv34n1-1.pdf

Nuno Gominho

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Author: studentnovasbe

Master student in Nova Sbe

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