Why don’t we see more price gouging?

by on September 23, 2003 at 3:07 pm in Economics | Permalink

I survived hurricane Isabel, but couldn’t buy a flashlight or the right size batteries, the night before the storm was to come. Merchants let supply run out rather than raise the prices. C.C. Kraemer at TechCentralStation.com tells us that half of all states have anti-gouging laws. More significantly, merchants fear that customers will resent price increases during times of trouble. The testable prediction is that wandering “umbrella merchants,” as I have encountered in Manhattan, will raise their prices when it is raining. They have little reason to fear long-run negative effects on their reputation. I have found this to be true but can cite only two data points in its favor. Twice, when it was raining, I bought umbrellas for $10 rather than for the usual price of $5.

Kraemer suggests that we should allow price gouging in times of emergencies. This policy conclusion need not follow. Since supply is constant in the short-run, higher prices won’t give more flashlights to more people, although in the long run the economy will stand readier with emergency flashlights. Higher prices will allocate flashlights to those people most willing to bid for them, but at the cost of all buyers feeling gouged. After all, not wanting to be gouged is a preference too. And the subsequent decline in trust will eliminate other potential gains from trade.

Arguments by N. Gregory Mankiw and George Akerlof suggest that small costs of changing prices can have large macroeconomic effects. They focus on cases where prices remain too high and output is restricted as a consequence. In contrast, if a firm refuses to raise its prices, presumably it feels that the resulting “resentment costs” are higher than the extra revenue it would reap. First, the price changing costs are not small. Second, if the firm had initial monopoly power, as the Mankiw argument requires, keeping prices lower will not in general lower consumer welfare. (It is a tricky intertemporal problem, there can be cases where contrived ex post shortages pump up ex ante demand for the good, to the benefit of the monopolist and to the detriment of social welfare.)

I would repeal the anti-gouging laws, on libertarian freedom grounds, but I don’t welcome more price gouging as a means of making us better off. Markets are quite willing to gouge us in a wide variety of instances, just try hearing a good jazz show on New Year’s Eve. We should take it seriously when markets are not willing to gouge us. We can also ask whether people would be better off if they had weaker fairness norms, or better fairness norms, that is the next relevant question for assessing the costs and benefits of price stickiness. Just keep in mind that our current norms help keep our suppliers in line and limit their ability to defraud us.

Addendum: I’ve made some slight re-edits in the interests of clarity.

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