Price gouging and the elasticity of supply

by on October 30, 2012 at 9:06 am in Economics, Law | Permalink

Jeff writes:

…in fact it is quite typical for the consumer surplus maximizing solution to be a rationing system with a price below market clearing. I devoted a series of posts to this point last year. The basic idea is that the efficiency gains you get from separating the high-values from the low-values can be more than offset by the high prices necessary to achieve that and the corresponding loss of consumer surplus.

Why would we only care about consumers’ surplus and not also the surplus that goes to producers? We normally we care about producer’s surplus because that’s what gives producers an incentive to produce in the first place.  But remember that a natural disaster has occurred. It wasn’t expected. Production already happened. Whatever we decide to do when that unexpected event occurs will have no effect on production decisions. We get a freebie chance to maximize consumer’s surplus without negative incentive effects on producers.

This is a very clever post and it provides much to think about.  But I don’t accept the main premise that supply is inelastic.  Last night most stores were closed!  At higher prices more of them might have opened, and in fact in most places it was logistically possible to have a store open in Fairfax.  There might also be effects from mechanisms such as “should I leave these flashlights out for sale, or take the extra home to the family?”  Furthermore the periodic demand for batteries, flashlights, bottled water, etc. around here has become (sadly) a regular event, where longer-run “option ready” supply arguably is linked to precedents from previous experience.

Orange14 October 30, 2012 at 9:22 am

” Last night most stores were closed! At higher prices more of them might have opened, and in fact in most places it was logistically possible to have a store open in Fairfax.”
This is one of the dumbest things I’ve ever seen you write! I live in Bethesda and even though I’m maybe 10 miles from Fairfax center, I doubt that our weather was much different from yours. We saw the winds pick up to 35 mph here with wind gusts 45-50 mph and you think somebody is going to keep a store open in expectation that customers are going to come in risking life and limb? Come on, and get real. Everyone was doing all their shopping on Saturday and Sunday in anticipation of this storm as can be witnessed at many of the stores around my area. By the end of the day on Saturday one could not find any canned soup, peanut butter, tuna fish, batteries, and other necessary things on the shelves of most stores. If you think price economics will lead someone to risk their lives, then something is wrong with your thought process.

I’m sorry but I just don’t buy this!

Tyler Cowen October 30, 2012 at 9:35 am

Last night I ate at China Star, bought grapefruit juice at Shoppers Warehouse (few of the shelves were empty), and would have seen a movie at Cinema Arts, if they had had Cloud Atlas showing. Maybe the people who live in Maryland really are weaker souls, as my neighbors long have been telling me. The waitress at China Star laughed off the whole event, for Fairfax at least, and compared it with normal storms in China.

Roy October 30, 2012 at 10:04 am

Exactly, the evening Ike hit Houston, I went for a walk after moving the family cars to higher ground. I wandered over to a small grocery and contemplating a couple weeks without power, bought ice cream. Then I walked past all the boarded up shops smelling the salt air from the Gulf forty miles away and the went into one of the several bars open to get a drink, all of whom were doing land office business.. On my way home I swung by another independently owned grocery and bought another ice cream.

All the chain businesses were closed, but a lot of the small businesses remained open till the storm hit. When you own the place you are far more concerned with chasing that last dollar, especially when you can expect a a week plus of almost no income.

Orange14 October 30, 2012 at 10:22 am

It all depends on where you live and how many trees are around. My area took a huge hit during the derecho earlier this year. It’s fine if one can walk around or drive along streets denuded of trees. I don’t buy your comment about Marylanders being weaker souls. I’ve done my share of hunting, camping and fishing over the years and am comfortable in the outdoors. That being said, when there are such high winds with trees that can go down and having to deal with drivers who may not know how to navigate inclement conditions puts one at risk. Now it’s fine for you to make that calculation if you have confidence that you understand what is at risk. Unfortunately most people are not equipped to do so.

The comment from your waitress is just plain stupid. One only need to look at the huge number of fatalities in China during disasters resulting from such storms.

Roy October 30, 2012 at 2:11 pm

The waitress is being tacky, but she isn’t wrong at all.

But how many of those casualties are from Cat 1 cyclones? A typhoon like this is not going to kill many people in any part of coastal china that is even close to modern, and all the deaths will be from landslides which are very unlikely in Toms River, New Jersey. I think you have no inkling of the scale of a Western Pacific storm.

I have been on both sides of this sort of thing. I’m from the Gulf Coast and I’ve gone out to dinner and the movies during a direct hit from a weak category 1 storm. I just recognize that New Jersey is a lot less prepared for this than Galveston, and to be honest Galveston is less well prepared than Hong Kong, or Hualien.

dirk October 30, 2012 at 10:56 am

I eagerly await the release of An Economist Shops During a Hurricane.

Dismalist October 30, 2012 at 9:36 am

As with all shocks, we must distinguish between expected and unexpected.

FE October 30, 2012 at 10:49 am

Interesting column in the Post today pointing out that many small businesses stayed open during the storm, while the large institutions closed. Then again, closing the large institutions makes room for the small ones to operate; the system can function at half-speed during a storm but not full-speed.

http://www.washingtonpost.com/local/petula-dvorak-in-a-storm-its-interesting-to-note-whos-essential/2012/10/29/b9b34e7c-21fe-11e2-ac85-e669876c6a24_story.html?hpid=z6

derek October 30, 2012 at 9:53 am

I would suggest all the pontifications about price gouging should also apply to double time wages for the various people responding to the emergency. Firefighters, police, linemen. Why should they benefit financially from the disaster. So they have to work long hours. Where is their sense of justice?

Claudia October 30, 2012 at 10:06 am

compensating differentials (or hazard pay in non econ speak) … keeps you from writing mandatory thank you notes, so be chipper.

derek October 30, 2012 at 10:15 am

I don’t begrudge these folks what they get, nor do I begrudge anyone having something for sale that people want, something in short supply, and charging the going price for it. I see no difference between the two situation except for the moral outrage.

Claudia October 30, 2012 at 10:54 am

Ok, I see your angle now. There’s a few issues that probably are at play: the goal: provision of public goods vs making private profits, the storability: first-response services happen in real-time vs sale of storable goods, attitudes toward emergencies: seems to be a moral outage at people who profit from others misfortune and an elevation of those who help the misfortunate. Retailers can certainly work this margin in ways other than prices and it’s a dynamic game…maybe stores don’t even want to maximize producer surplus in crisis…as these crises pass.

PrometheeFeu October 31, 2012 at 5:17 pm

Don’t firefighters, police officers and other first responders get private profit from their salary? Sure, they do an important job, but then again, the guy selling me water also does an important job.

Mark October 30, 2012 at 10:02 am

Production may indeed have already occurred, but it doesn’t mean that resources are still allocated efficiently. The storm made resources more scarce for those who were affected by the storm. Higher prices for goods and services create the incentive for people living outside damaged areas to mobilize their goods and services to those affected by the storm. If prices aren’t permitted to rise, this is not likely to happen.

Andrew' October 30, 2012 at 10:09 am

We also think nothing of power line repair trucks driving over from Missouri.

Orange14 October 30, 2012 at 10:26 am

Quite right. Our utility PEPCO has been criticized in the past for not getting crews in quickly enough. So they get a lot of extra crews lined up but the outages did not materialize in our area (thankfully) and such crews are not needed. In Tyler’s neck of the woods, Dominion Power had about 120,000 outages as of early this AM so I assume the extra trucks can be diverted there. With a fragmented power grid, it’s a complicated logistical matter in addressing disasters.

RobertB October 30, 2012 at 10:08 am

The justification for disregarding producer surplus seems extremely dubious. Yes one reason we care about producer surplus is incentives, but another reason is that producers are people too, or they’re owned by people. I don’t buy the idea that deadweight loss is no worse than a transfer whenever there are no incentive implications.

Paul Zrimsek October 30, 2012 at 10:20 am

This. If we’re talking about surplus in the first place, we’re presumably doing welfare economics and we care about producer surplus because surplus is good no matter who pockets it.

Marc Roston October 30, 2012 at 10:17 am

We ignore producer surplus at our own peril. Frankly, I’m far more confident that Walmart can get the right merchandise to the right locations than the government could.

In Northern NJ this past weekend, who had the seemingly endless supply of bottled water? Walmart, Costco and Home Depot. Who will get the generators here for my neighbors without power? Same companies.

Even more “generously” from a producer perspective: All of these companies stand ready to accept returns of everything each of us buys, and doesn’t actually need or want to keep!

doctorpat October 31, 2012 at 3:25 am

Result: Thousands of Manhattanites enter a Walmart for the first time in their lives, and find that it’s filled with all sorts of useful stuff, and that chewn’ ‘baccy and marrying your sister are NOT conditions of entry, contrary to what NPR told them.

Orange14 October 30, 2012 at 10:28 am

Abject sexism at work?

Tyler Cowen October 30, 2012 at 10:51 am

That was some scoundrel posting under my name, not me.

Andrew' October 30, 2012 at 11:16 am

So, is treating sex like a good sexist or feminist? Or does it matter who is doing it?

Yancey Ward October 30, 2012 at 10:31 am

What does he think- that the entire country and world was devastated by the event? Even if production is at a standstill in the affected area, there are non-devastated areas whose resources can be mobilized with the proper price signal. One would think the writer is advocating that the rationing be applied over the entire country, and if this is the case, then there is no case for removing the rationing once the event is finished.

CC October 30, 2012 at 10:47 am

Tyler, I think you may have been alluding to this, but I’m not sure.

This stuff about “But remember that a natural disaster has occurred. It wasn’t expected” is nonsense. Disasters happen once in a while. If companies are allowed to raise prices during disasters, then they’re incentived to keep extra supply on hand during normal times (just in case something out of the ordinary happens).

This isn’t just theoretical. I’ve done business transactions with this exact principle in mind.

Brian Donohue October 30, 2012 at 12:20 pm

+1.

Don’t economists generally agree that “opportunistic” behavior in these situations is generally welfare-enhancing and mutually beneficial? Nobody’s holding any gun to anybody’s head here.

But as humans, we ALL have an instinctive reaction of outrage at this “opportunistic” behavior.

Ultimately, are we ruled by irrationality here? It seems to me that when a ‘feature’ of our heritage starts to look like a ‘bug’ in modern society, we try to overcome it.

John Schilling October 30, 2012 at 11:13 am

Among other defects in this analysis, there is an overly-narrow definition of “producer” at work. The relevant good is not e.g. “flashlights”, for which the producer is a factory somewhere in China which, yes, Jeff, will basically ignore the price impact of the hurricane. The good is “flashlights available in coastal Virginia”, and the producers include e.g. truck drivers wondering whether it is a good idea to drive a very expensive truck full of similarly expensive cargo into the path of a hurricane.

Potential negative impacts on the decisions of those producers, are left as an exercise for the student.

Darin Johnson October 30, 2012 at 11:17 am

CC – exactly right! Maybe – maybe – you can fool the producers once and force them to give up their surplus during a disaster. But that ensures that the surplus will not be there next time. Jeff at Cheap Talk would be well advised to consider Thomas Sowell’s standing question for tinkerers: “And then what?”

jeff October 30, 2012 at 12:14 pm

Taxis in DC were allowed to institute a $15 surcharge on all fares last night. The fact that the taxicab commission even bothered at least shows some cabbies were willing to brave the storm. Did any DC residents try to hail a cab last night and want to share their data on how it went? The taxi driver in my apartment building had his car parked safely away all day and night.

Chuck October 30, 2012 at 5:34 pm

I took a cab last night in downtown DC. About 7 PM. The weather was not terrible but was unpleasant. I saw only one other pedestrian. After walking several blocks I decided I would be too late and I better find a cab. Easier said than done—I did see a few cabs with passengers..

I walked over the JW Marriott hotel. No cabs waiting. Soon afterwards hailed one on the street. Even with the surcharge the supply of cruising cabs was low.

Of course, there was no congestion—got to my destination quite quickly.

Chuck

Spencer October 30, 2012 at 12:19 pm

But the point that needed to be made is that Wal Mart, Home Depot, Lowes, CVS, ACE Hardware and many other national chains do a great job of mobilizing supplies from parts of the country not impacted and bring needed supplies to areas hit by storms and selling them at normal everyday prices.

One of Wal Mart’s 14 wheeler supply trucks can bring in more supplies than hundred of the proverbial guy selling out of the back of a pick up truck.

You have a beautiful theory that you teach in intro economics, but that does not mean that you should ignore the reality operating right under your nose that strongly contradicts your simple theories. You can still teach your theory as an over-simplified demonstration of some basic principle, but don’t believe that it is more than that.

Yancey Ward October 30, 2012 at 12:44 pm

Nothing in your comment contradicts Cowen’s working theory, Spencer, and, in fact, supports it. The Walmarts and others are acting voluntarily.

Spencer October 30, 2012 at 1:53 pm

No Yancy, Tyler’s thesis is that higher prices are needed to induce this supply response.

That is what I strongly disagree with.

The big box chains increase supply without raining prices.

Yancey Ward October 30, 2012 at 2:46 pm

You are pretending they are the only sources, Spencer. In addition, you are ignoring the hoarding factor.

Andrew' October 30, 2012 at 4:27 pm

Corporations make transactions murky, not non-existent. They don’t go from evil to angels overnight. They don’t raise prices because you don’t perceive them raising prices.

Paul Zrimsek October 30, 2012 at 12:51 pm

So anti-gouging laws are basically paternalistic measures to protect the dummy-dodos who pass up the plentiful, low-priced supply at Wal-Mart in favor of the overpriced, hard-to-find stuff out of the pickup truck?

anon October 30, 2012 at 7:35 pm

From living in Florida and being in a disaster area, these responses are nowhere near enough to handle the market demand for ice or gasoline. We drove 50 miles from Palm Beach county to Dade county to get some ice and gas after one of the hurricanes. Walmart and their trucks were completely out of all those kind of supplies.

I also lived in Atlanta after a scare on gas supply when a hurricane took out some pipelines. Many stations ran out of gas quickly because people all decided to fill up at once, long before they needed it. I thankfully had a full tank right before the scare, but as I got close to empty after a week, I ended waiting over an hour for gas. This was all due to price gouging laws slowing down the rate at which the pipelines were prepared or how much gas could be trucked in.

PrometheeFeu October 31, 2012 at 5:26 pm

Ah, so what you are saying is that there is currently no shortage, everything is fine and therefore, anyone who buys at gouged prices is just a fool who forgot to check out the local Walmart. Is that what you mean? If that’s the case, are there really so many fools out there that we need laws to tell the fools not to buy for a high price what they could buy for a low price?

Alex Tabarrok October 30, 2012 at 1:11 pm

Producers are people and deserve to be counted as much as consumers.

Collin October 30, 2012 at 1:21 pm

Of course, isn’t the producer surplus here the small stores that stay open during the storm. Why don’t they double or triple their prices due to the weather? Probably because price gouging is hurts the long term customer relationship so consumers will pay the high price today but will never return to the location. If they leave current prices, then the customer might continue the business with the vendor. So by not price gouging the producer surplus might be continue customer long term versus the immediate $5 markup.

I remember some of the gas stations that sent up gas prices to $5.00/gallon on 9/11/2001 got their name in the paper and lost a ton of business for the next six months.
CR

Lord October 30, 2012 at 3:02 pm

Perhaps you should consider that the effect of price gouging would not be to increase elasticity but decrease it. Once price gouging becomes acceptable, it becomes irresistibly attractive and competition rather than reducing it, develops more and newer means of pursuing it.

anon October 30, 2012 at 7:41 pm

????

I cannot believe the economic arguments that arise from a discussion of price-gouging laws or gas prices. To do what you’re saying, all the suppliers would basically have to collude together. If there, say, 10 gas stations who decide to put prices 50 cents above what they cost, one station could charge only 45 cents above cost but get 100% of the business. As there are more participants in a market, then it gets closer to cost for the suppliers.

If it’s true that such collusion would happen after disasters, then why wouldn’t such collusion keep happening? In the case of gas stations, they make very little margin on gasoline. The same goes for groceries. The increase in volume from slightly lower prices typically overwhelms the gains from trying to collude with others.

Lord October 30, 2012 at 10:44 pm

Because it is frowned upon and illegal. Collusion need not be open, it is not in any of their interests to compete and obtain all the market. Even Dupont was careful only to control 80% of the markets they competed in as long as they were the lowest cost producer since this let the market swings bear on the lesser players. Competition is never complete but heavily driven by geography and logistics. It is not in their interest to lose money and they can’t make up for a loss by volume. So while they compete somewhat on price, they compete much more on service, selection, quality, advertising. The increase in volume rarely makes up for the loss in price. They approach with different strategies instead. You need to close the book and look into the real world.

Lord October 31, 2012 at 1:47 am

A really interesting simulation of these effects is Steve Keens Behavioral Finance Lecture 2 Part 2 (4 of 21) starting around 9:30. http://www.youtube.com/watch?v=jiJMzDtGOlE&feature=BFa&list=SP0A21A329D01D0CFE

Lord October 31, 2012 at 7:46 pm

The mistake neoclassics make is to assume competition means each is ignorant of what the other does or will do, but game theory applies and the more each knows what the other does or will do, the more competition will be avoided, as this is the rational response.

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Stuart Butler October 31, 2012 at 12:42 pm

“Price gouging” presents us with a moral question — Is it wrong for a retailer to make “excessive” profits in a spot shortage due to a catastrophy when his neighbors are suffering and goods are in short supply? But also an economic question — how do we properly regulate supply and demand while encouraging suppliers to channel products to where it is shortest supply and most highly valued, and assure that the buyers are those who need/value them most? Is this a possible answer to the conflict between morality and sound economics? Let the retailer post a sign (and allow verification) that he will sell at the market rate, but limit his profit to the “normal” level while contributing the difference between that normal profit and his costs (which will likely incrase during a natural disaster as his suppliers adjust their supplies and prices) to a fund to assist needy neighbors to afford adequate provisions?

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