Price Gouging, and Why We Need to Change the Name
You may have encountered higher prices for certain goods recently. While this may be legally classified as price gouging, there are different underlying motives to raise prices. Two that immediately come to mind are the rising cost of inputs and the desire to increase profit. We can drill down even further than that. What inputs are involved with the production of goods and services? To figure that out we need to compare several examples.
The best discussion I have heard on the different facets of price gouging is the EconTalk episode Munger on Price Gouging. The discussion centers around a story where, after a violent storm, two people chose to traverse difficult weather and road conditions to bring ice to a town suffering a shortage. A line of people formed to buy the ice, and when people got to the front they learned that bags of ice were selling for several times the typical price. Before we jump to the end of the story, let’s look at some more examples.
After a highly attended event, or even during a catastrophe, people trying to get an Uber will face surge pricing. Here’s a more recent example. Anyone trying to get N95 masks over the past month has faced nearly insurmountable difficulties and the masks available have marked up prices. What do all these examples have in common? One similarity appears to be rising input prices.
In economics, an increase in the cost of inputs would shift the supply curve to the left and raise prices while simultaneously reducing output. Counterintuitively, by enforcing strict price gouging laws we are further reducing supply in times of a crisis.
Let’s revisit the story of people providing ice to the town in need after a storm. Unless they could afford to take net losses, these people had to recoup their unusually high expenses. They had to travel under dangerous circumstances to procure all this ice. The same holds true in our other examples. With certain crises we naturally want more Uber drivers on the road. For that to happen, surge pricing is practically a necessity to compensate drivers for added risks as well as to raise the opportunity cost of not being on the road. Lastly, with these N95 masks, there is a temporarily short supply. If we try to enforce price gouging then the likelihood of people in need receiving these masks becomes even slimmer.
There is a lot to unpack in the price of a good or service. Besides compensating the supplier for increased costs, higher prices help make sure the goods go to the people who need them most. In the ice example, the town was dealing with a limited supply. People who got to the front of the line and needed the ice for a party would hopefully be deterred by the inflated cost. Conversely, people who needed the ice for medical emergencies would be willing to pay the higher price. This helps ensure that the limited supply flowed to the people who needed it the most.
We have to keep in mind that incentives affect behavior. To complete this diatribe on the strict enforcement of price gouging, let’s take these examples to their logical conclusion. In economics we would be dealing with perfect competition because ice, car rides, and N95 masks are all fairly standard products. So, should someone in a perfectly competitive market start making economic profits, more suppliers will enter the market until the price moves down towards equilibrium.
We should not be preventing people from raising prices to charge at-cost. Moving forward, we could limit anti-gouging laws to cases of extremely greedy pricing. That way we are still able to learn from prices and, in some cases, bring more suppliers to the market.