More on price gouging

by on September 24, 2003 at 7:23 am in Economics | Permalink

Click here, here (scroll through, their archives aren’t working), and here to read some responses to my earlier post on why we do not see more price gouging.

I agree gouging should not be illegal, the question is why the refusal to gouge persists when gouging is legal. Here are some possibilities:

1. People are just irrational, gouging would be an improvement over shortages.

2. Gouging would violate fairness constraints, break down our trust in business, and lower the overall gains from trade.

The above links discuss these options. Last night I was pondering another hypothesis, to be sure it has some holes, but since the absence of gouging is often a puzzle, let us look more closely.

3. Non-gouging is a form of price discrimination that raises long-term profits, for reasons that have nothing to do with fairness constraints.

I was first pondering the case of airlines. It is sometimes argued that airlines keep coach quality low deliberately, to raise the demand for business and first class tickets. I don’t know if this is true, but an analogous argument can be made in the intertemporal context. If flashlights are scarce when a storm comes, the pre-storm demand for flashlights will rise. Conversely, if the flashlight market clears when a storm comes, fewer people will stock up on flashlights in the first place.

Assume that right now flashlights cost $5 (laugh at this number if you want, I haven’t bought a flashlight in ages). If prices cleared the market every period, flashlights might cost $20 when there is a storm, and $4 otherwise. Both the wealthy and the careless might hold off on flashlight purchases, knowing they can always get one at the last minute, if they need to. So fewer flashlights are sold up front. By keeping flashlights scarce during a storm, the store forces people to invest in a flashlight now as a form of insurance against not being able to get one later. This might raise the overall demand for flashlights. In similar fashion, perhaps sports arenas (another classic venue for non-market-clearing prices) may not wish to give everyone the option of showing up at the last moment to purchase tickets.

What are some of the holes in this argument? First, the store must have some market power (but note that most plausible explanations of sales and coupons require this same assumption). Second, the numbers need not work out in favor of keeping the price steady. Third, why would this effect hold for flashlights and not for all commodities? Fourth, I can think of gouging cases where this argument would not apply. I recall a peanut butter shortage about twenty years ago, and the market did not clear, it is hard to imagine that this encouraged people to stock up on peanut butter.

Still, the absence of price gouging is a puzzle, and we need to look at all available explanations. Intertemporal considerations might be part of a broader understanding of the phenomenon. Perhaps market-clearing prices don’t boost profits as much as we would otherwise expect.

Addendum: Gary Leff offers an instructive post on the pricing of airline seats, more generally check out his excellent travel blog.

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