Seller Reputation and Price Gouging

That is a new paper by Luís Cabral and Lei Xu, here is the abstract:

We test the theory that seller reputation moderates the effect of demand shocks on a seller’s propensity to price gouge. From mid January to mid March 2020, 3M masks were priced 2.72 times higher than Amazon sold them in 2019. However, the difference (in price ratios) between a post-COVID-19entrant and an established seller is estimated to be about 1.6 at times of maximum scarcity, that is, post-COVID-19entrants price at approximately twice the level of established sellers. Similar results are obtained for Purell hand sanitizer. We also consider cumulative reviews as a measure of what a seller has to lose from damaging its reputation and, again, obtain similar results. Finally, we explore policy implications of our results.

In other words, Amazon is afraid to raise its prices, presumably for a mix of reputational and regulatory reasons.

Comments

Price gouging is a valuable tool in the toolbox of any demand and supply shock surveillor, Amazon and Microsoft are nonethewiser.

Price gouges do absolutely nothing to increase supply, but rip off taxpayers.

Ripping off taxpayers is valuable tool, why?

How come price gougers do nothing to increase supply? That seems to. me a false statement.

For the same reason ticket scalpers don’t increase the number of seats in an arena. Because in the short run, supplies are fixed. That’s why prices rise when demand shifts. If there is not a high enough price in the short or long run to justify the necessary investment suppliers will not take on the additional costs based on risk modeling. So all that price gouging does in the short term is turn middle men retailers into profiteers.

In other words, because prices are incentives wrapped in signals, prior to the pandemic, suppliers had already responded to all available incentives to build their business and maximize utility. The isn’t extra capacity in place to raise supply in the short run as any extra in normal times results in inefficiencies.

So no, retail and black market price gougers do not increase supply in the short term. They may in the long run, but that requires a return on investment for the actual supplier.

So it better allocates the existing supply by providing the goods to buyers who value it more as well as encouraging the use of substitute goods. You can think of this as increasing supply.

It also changes some goods from consumables to status items. I personally don’t think the utilization of scarce resources for status seekers is a benefit to society at large.

If this happens is it significant in this case?

It also reduces existing supply, literally.

Adding legs to the logistical tail removes goods from the market for some period of time. For instance, if you buy up a shipment of N-95s you have some period of time where ownership transfers to you before you can legally put your shipment on the market. So, at best, you buy the container in a warehouse and spend a brief bit of time relisting and repricing the goods. Unfortunately, more often we see resellers either go out and mass buy up retail shipments or take physical custody (often requiring movement to a new facility). This means the products are gone for a certain number of hours or days.

Worse, when you change the logistics networks for something which can be easily spoilt, like N-95s, new entrants will likely increase the amount of spoilage in the supply change. For instance, if you ship masks by air freight in conditions of high ground humidity you can have ice damage and spoil a shipment. Likewise, if you try to do quality control you can degrade the viability of the shipment if you manage to introduce errors into the paperwork chain.

Every time a product changes hands there is a risk that some of it will be handled improperly. Hopefully, this is small, but adding in a layer of price gougers who do nothing but by, handle, and resell will have some negative effect on overall supply.

Likewise, there is the criminal aspect of things. High profit margins, particularly headline numbers well beyond market clearing prices, induce criminal behavior. For instance, in our ED we have had several patients attempt to steal boxes of masks because they believed they could resell them for drug money. As these folks are active drug users, the odds that they will contaminate these masks is quite high. The odds that they will actually find somebody who will fence them is quite low. Most likely the boxes that walked out the door ended up in a dumpster.

In response we now burn huge amounts of man-hours protecting our PPE. Gone are the boxes waiting on carts in case there is soiling. Now we have to stop patient care or send a runner. I do not think this has killed anyone, yet, but it will happen should we hit NYC levels around here.

Then, of course, there is the fraud angle. If you raise the profit margins high enough on reselling legitimate goods, you will invariably have knockoffs and bad batches entering the supply chain. This is made worse, of course, the more new entrant resellers the more chances there are that somebody will not be savvy and get a bunch of defective masks (or whatever) dumped on them. Worse, once this becomes a real risk, we end up needing to sacrifice larger numbers of goods to quality checks.

Your model assumes a frictonless movement of good from the supplier/primary retailer to the reseller and back to the market. This does not and has not happened with N-95s, surgical masks, or any of the other goods my logistics people have been running down. We have had increased costs from fraud and theft prevention. We have had temporary disruptions on the "spot market".

All the real world frictions, at best, offset the efficiency gains by buying out low priority users by diverting large amounts of money away from producers and consumers. At worst, the increased spoilage and defectives lead to net lowering of well being.

So no, this is nothing like new supply. It is like taking old supply and burning it.

Amazing how many excuses you can trot out in favor of your mood affiliation. Bravo, you are smart. Also, you are a doctor and not an economist. By the way, you were responding to this comment "providing the goods to buyers who value it more as well as encouraging the use of substitute goods". Did you forget? Because neither of those things is taking old supply and burning it.

All I know is that for the actual products under discussion the actual behaviors being explored, namely reselling and unrestrained pricing, have had negative effects in the real world.

Somehow people forget that economics is a series of models. Some things are easier to model than others.

I would submit that medical supplies, which can have catastrophic modes of failure in an epidemic with exponential potential, are going to be less amenable to back of the napkin models about allocation efficiency.

In the real world, we are burning real resources as all this magical reallocation has helped contribute to diversion, bottlenecks, and spoilage.

Supply is not fixed. There were a lot of distillers who switched to making antiseptic gels. They would most undoubtedly have higher costs and would charge more. And I like my small batch hand gel.

Scarcity and the supply/demand models implicitly and explicitly state that supply is fixed at any moment in time. Supply fluctuates over time and the differences between near and short term will be different for goods and services at any moment in time. For right here and right now supply is fixed. The entire school of economic thought is built on the scarcity of resources.

Scarcity exists, for sure, but supply is not fixed. I just gave you an example where it was expanded.

No, you gave me an example where supply changed over time. The distiller doesn’t have magical powers that turned distilled products on the shelves into hand sanitizer instantaneously. Right here, right now supply is fixed. In 1 hour, there will be a different fixed supply. In a day, another, and so on and so forth for eternity. It’s precisely why economists say prices should fluctuate. It’s why two guys in Tennessee drove around their state buying up all the supplies they could so they could resell them on EBay and Amazon. It was the short term fixed supply that allowed them to sell hand sanitizer at rates 90 times what they bought at. Magical thinking about infinite supply isn’t going to put toilet paper on the local shelves unless you believe the manufactures are holding back because they don’t want to sell.

Horrific goalpost-shifting. "I didn't mean the short run, I meant this second right now!" Lame.

The increasing prices are signals to increase supply. The fact that it doesn't happen instantaneously is no argument against the practice.

In addition to bringing in additional supply it better allocates what is available.

Obviously the shorter the time horizon, the more fixed is the supply. In a long enough run, nearly all supply responds to increased prices.

Remind me again, how much stronger is this "signal" than people dying in mass, the president invoking the Defense Production Act, or all your regular customers trebling their orders?

I hear an awful lot about this being a "signal" but surprisingly little about how strong it is in either absolute or relative terms. Exactly how high does price need to go to elicit a response from supply? Is your signaling function logarithmic, exponential, linear, or of some other character?

Do not get me wrong, I would keep shoveling more money at 3M and the like, but I am not seeing all that much utility from 200% to 250%, let alone up to 1000%. If we want to say this is a signal, then what is its bandwidth and how responsive is the supply?

What I can say is that I have seen, in real time, how resellers have despoiled masks, temporarily removed them from the supply (creating local bottlenecks in hopes of cornering the local market at inflated prices), and of course, incentivized theft. So exactly how many more masks should I be expecting if the price doubles? How many more if the price trebles? How many of those will be functional and how many will be defectives being slipped into the logistics stream?

Nobody doubts that raising prices will eventually bring supply to the market. We just doubt that it will occur soon enough to matter and the downsides of gouging (increased incentive for theft and fraud, increased spoilage rates, and temporary stock dislocation) are happening now. And if we continue to believe that Covid is going to go exponential again soon, then conditions now matter a heckuvalot more than conditions in six months or a year when supply comes online.

Remind me again, how much stronger is this "signal" than people dying in mass, the president invoking the Defense Production Act, or all your regular customers trebling their orders?

Trebling of orders at the same price is not a useful signal at all. Perhaps you, the manufacturer, have extra capacity that can be brought online at no additional cost, but that is not likely. More probably, you'll have to pay overtime for another shift, or you may hire new workers who need to be trained and work at lower efficiency. You may have to bring old retired, less efficient machinery out of mothballs, or look for machines on the spot market (at inflated prices). And a trebling of your orders sends NO signal to other companies who are not currently in the business. They don't know your orders have trebled. And even if they did, they wouldn't jump in, because startup costs are high and when they manage to get their new lines operating, they can only sell at the old, fixed non-scarcity price. Meaning they'd likely lose money on the whole effort. The 'hey we REALLY need more of this stuff but only at the old price and only for a little while' is a poor incentive for existing and prospective producers alike.

Nonsense.

Keeping my numbers simple. Say I buy a box of X for $100. It cost the manufacturer $50 to make it. I say hey, there is a pandemic on and I want 3 boxes.

I treble my order. Maybe the next box off the line costs them $75 to make. Whatever, they still churn a $25 profit on that box. Maybe getting me my third box of X costs them $85 dollars to make it. Their profit still goes up.

Nobody gives a rat's ass about the price. They care about their profit. And this is trivial to see. After all, if the state increases prices (be it through mandatory minimum prices, taxes, or regulation) it does not induce increased supply.

Trebling my orders is close to the same in this example as telling my X company that I will pay $140 for one box.

And no other companies are aware. After all it is not like prices are static on everything. If my company suddenly needs 3x as much raw material, that will move the prices of those raw materials. And gee golly, the CEO of firms remotely interested in this space might, just might be able to think through that we have a pandemic going on, a mask manufacturer just bought up more raw material, and reasonably infer that more orders are going in. More, we are dealing with humans and these orders, not being state secrets, will be known often in great detail.

Again, I get that higher price moves the needle on supply towards increase. How much? If we treble the price am I going to get even a 30% increase in the supply?

It is all well and good to say that a price is a signal, but so is the nightly news. So is the Defense Production Act. If we strip the incentive from price (by paying to resellers), exactly how strong is that signal?

I could be wrong, but most all of us are willing to pay 3M more. God knows we offered and are currently only paying pre-scarcity prices on contracts signed during the early first quarter. I just see extremely little utility in incentivizing fraud and theft in the hopes that somebody, somewhere will pick up on a price signal of 250% normal price (instead of 200%) and miss every other signal out there.

Because ultimately we are dealing with people. People who watch the news and read trade publications. At some point the utility of price increases diminishes if all the incentive is going to a reseller leaving the manufacturer with peanuts.

You can tell me that paying manufacturers more will lead, in the long run, to more manufacturing. You cannot tell me that a reseller commanding high prices will be a signal so that some manufacturer will somewhere, someday enter the market or increase the production.

I mean at the end of the day suppose I paid $10,000 per mask. Everybody goes into the mask business. What further supply could be gained at a $100,000 or $1,000,000? At some point the signal value has a diminishing rate of return and everything I am seeing, like the big guys not upping their own prices crazily, suggests that we may already be at or past that point of diminishing returns.

If the marginal cost was only $50 and the market price for that good is $100, why on earth would there not be more people entering that market to sell them at a 25% discount, get all the business and still make economic profit?

Almost as though you are being intentionally obtuse. The math works the same if the production costs are $95, $97.5 and and $98.5.

We get real world profit margins are single digits, but increasing quantity sold functions similarly to increasing price.

And what if the production costs are $95, $105, and $115? Did you NOT THINK OF THAT??? It's almost like you're pulling numbers out of your ass to justify what you would like to believe.

Almost as though I began my remarks asking what the utility gain was going from 200% of pre-scarcity price to 250%.

I get that there needs to be some price increase in times of scarcity for a variety of reasons. The signally aspect thereof is the weakest of any of them and I am still waiting to here actually how the magnitude of price varies with signal utility.

Supplies are absolutely not fixed in the short run. Run an extra shift, burn through your supplies quicker and buy more supplies at higher prices, pulling them out of other uses, etc.

3M didn't raise their prices either. In fact they went after fraudsters and gougers serving them lawsuits. They must flexing their muscle up and down the chain to keep up the image of a good corporate citizen who acts steadily and responsibly during a crisis. A reputation (brand) is hard to acquire but quick to lose. It also tells you that price gouging at least in this case didn't move the profit to the producer but to the liquidity providers, hoarders, and speculators. In theory price gouging makes sense but in reality it doesn't always work out. Like communism.

https://www.businessinsider.com/3m-sues-company-for-trying-to-sell-fake-n95-masks-price-gouging-2020-4

Those who think price gouging are a good thing support patent monopolies on drugs to rip off taxpayers.

Eg, the patents on the Hep C treatment result in lots of lobbying to get government to pay really high prices for drugs with marginal costs of a few dollar to cure Hep C in prisons based on the big saving on treating all the complications of liver disease of people who will never be able to earn enough to be treated and thus all the costs fall on taxpayers.

Vaccines not included on the CDC/CMS "childhood" vaccine llist can never be sold in quantity to generate high profits, so drug companies lobby government to get paid, as in Gov Perry having taxpayers pay for the new STD vaccine.

Given for profit corporations won't build factories to manufacture all the PPEs the US needs based on public health recommendations, the government should. Build the factories, contracting with health care providers to contract with their preferred PPE makers to specify the factory equipment and then operate it for say 5-10 years with providers buying all production at cost.

Conservatives oppose this because too much supply means no profit, thus no "wealth creation", ie, inflating share prices. As in, a million dollars raised to build a factory for a million in labor costs can't be inflated to. $100 million, creating $99 million in "wealth."

+1. If the rewards of price gouging actually goes to the producer, then there would be some intellectual backing behind it and the funds could be used to expand production (though many would still disagree with the practice). I think Alex made this point. Price gouging is an absolute failure if the consumer pays a much higher price and the producer does not see the extra profit but instead goes to scalpers. Most agree that this is the all too common equilibrium in the real world.

Worse, the profits can be cannibalistic.

If prices are perceived to be high enough, drug addicts will steal masks instead of iphones or laundry detergent to fund their habit. They will inevitably contaminate a large number of the masks and at best they sell them back into the same logistics stream where the people they stole from have to rebuy them.

Even worse there are always defective masks and other items. I am told that our logistical stream is having more of these defective masks fraudulently entering. Again, you have a bunch of new players, some of whom make rookie mistakes, and now we have to either sacrifice more to quality control or we have risk using defective equipment.

We want the profit going to the manufacturers. We do not want it to go to whomever happens to be holding the masks when news break. The latter is a recipe for fraud, theft, and all manner of things worse than a strict shortage.

3M not raising its prices in the face of increased demand is a form of "predatory pricing" that discourages market entry by new producers.

Where is the outrage?

+100

Came here to say this exact thing. Same business with Amazon pushing for a $15/hour minimum wage, they don't hire many, if any, who produce less than $15/hour worth of labor, but they know their competitors do, and are trying to raise their competitions' costs.

Or perhaps marginal producers have higher marginal cost?

My thoughts exactly. If they had lower opportunity costs, then they would've entered already. But perhaps the authors took care of this objection to the conclusion.

The problem with that argument is that it was not marginal new producers, but simply resellers.

These were not new producers, but new resellers: "In the first model, we compare Amazon.com with third- party sellers, and further distinguish between incumbent and entrant sellers. Amazon is a platform where an item can be sold either by Amazon.com or by a third-party seller."

That "third party seller" could also have been my grandma, tho, who's now sewing masks.

Sure, but, unlikely, so face the facts in the real world.

Third party sellers are not typically resellers.

You want your story on both youth movements and price gouging? Students at University of Chicago demanding a 50% tuition cut due to the virus. If too many universities resort to web-based learning then a few things come to mind. One, their value proposition drops greatly as you now lack the social networking and important face time with faculty and other students. Two, if online learning is the future then why not open up your enrollment to anybody with an internet connection? Lastly, the internet makes everything cheaper so are universities going to finally drop their sky high tuitions? The marginal cost of internet is zero.

https://chicago.suntimes.com/education/2020/4/30/21242961/university-uchicago-tuition-tuition-strike

So Amazon shirking their capitalist responsibilities by not raising prices, hence discouraging new entrants into the mask making business, and distorting the free market price signaling mechanism? Noted.

Whether intentional or not, Bezos is the Keynes ideal capitzlist.

A shortage of supply to meet demand calls for building more capital to increase supply.

Consider Amazon's response to increased demand is not raising prices to cut demand, but investing in capital to increase supply.

So far, supply has been increased by hiring 50,000 more workers to operate existing capital well above the optimal utilization. Thus costs have increased resulting in costs rising faster than revenue, but Amazon is also building more capital, more warehouses, trucks, etc

My guess is someone at Amazon is looking at various PPEs and hand sanitizers and the costs of factories and labor, then doing make/buy decisions. Eg, Amazon looked at delivery, eventually deciding to build it's own delivery capital, which it keeps experimenting in franchise models. It looks like the current experiment is Amazon supplies delivery trucks to contractors, along with software route management, and the contractors supply labor. To the end user, its Amazon delivering the goods, even if it isn't. Note, the USPS uses this model, with "rural routes" delivered under a franchise model while the other, mostly "city" routes are delivered by employees. A dual delivery model going back more than a century.

So, Amazon like its predecessor Sears offers it's own products under it's own brands, Amazon Bssic vs Sears Craftman.

Sears screwed itself by prioritizing profits to "create shareholder value". It was the Everything Store with substantial control over its supply chain, all run without (economic) profit.

And that is the problem with Milton Friedman's theory of capital scarcity to maximize profits - those businesses self destruct.

Keynes offers the path to longevity: building capital until profits and rents fall to zero.

Capital is built only by paying workers. No free lunch.

Not a good example of Amazon shirking capitalism. A better one is failing to give their workers better pay and conditions during a pandemic. Or as a former Amazon VP who just resigned put it "chickenshit"

https://www.techdirt.com/articles/20200504/10502544429/tim-bray-early-internet-guru-amazon-vp-quits-over-chickenshit-companys-targeting-employees-speaking-out-about-covid-19.shtml

Compensating wage differentials will clear the market, including the guy who quit in protest.

Amazon doesn't care about prices being raised on more than half of its sales, that being the amount of sales that are from Amazon's third party sellers.

And because those third party sellers can damage Amazons reputation more than their own, Amazon decided it was in their best interest to limit the option on those third party sellers to raise prices on certain items during a pandemic.

Some would call this the free market at work. I remember when libertarians would tell me reputations were important in a non-regulated world.

Amazon decides what is in Amazon's best interest, and has no problem getting rid of a 3rd party seller. Especially when the 3rd party seller just happens to be offering a product that Amazon also offers. Luckily, during a pandemic, that is not considered monopolistic activity, but instead is an example of virtue signalling.

Well played Prior. Well played indeed.

Yeah +1

Ban Amazon from selling on its marketplace. Trivially obvious. Apple as well.

The incentives are aligned against the consumer.

Toilet paper (TP) and paper towels (PT). During the shut-down I have used a shopping/delivery service to purchase groceries. Of course, the supply of TP and PT has not kept pace with demand, caused by panic buying. [Technically, there has been a shift in the demand curve triggered by the pandemic, not a shift in the quantity demanded triggered by a price change.] One enterprising worker for the shopping/delivery service kept an abundance of TP and PT in her car, just in case a customer might be low on supply. How she picked the price would be an interesting study, but her price definitely exceeded the grocery store's price (which is out of line - the equilibrium price - with the demand). This reminded me of the enterprising Uber drivers who offer their phone numbers in case I need a ride in the future, cutting out the middle man in the bargain. Gig work implies freelancing, but that's not technically the way it's supposed to work in the so-called gig economy, which has a hierarchy that is designed to reward the middle man (Uber, the shopping/delivery service, etc.) through which the gig worker and customer connect (often through an app). Do gig workers have the same concerns about reputation as employees? I think not; after all, the employee has a long-term view of her relationship with her employer but the gig worker does not (it's only a gig). Reputation is less likely to conform a seller's behavior to what is considered acceptable or moral in the gig economy because the contact between the seller and customer is through the gig worker. Indeed, the gig worker is more likely to charge the equilibrium price than the seller (Uber absorbs billions in losses in its business model while the gig worker can't afford to absorb losses). All I know is that I have plenty of TP and PT.

Individual Amazon sellers may repurpose highly rated accounts and product listings, though, I flagged one top rated Dr. Seuss book listed that was changed to a face mask listing.

https://twitter.com/garyleff/status/1246389571962777601

Everything on the internet is gamed. I used to enjoy reading reviews on Amazon. Now it's all fake news.

having a deficiency of masks in our pharmacies, I monitored the prices for Aliexpress, somehow I did not think about Amazon. Thanks for the info.

This is consistent with my experience and reminds me of the Chicago Cubs in the early 2000s. Problem: they wanted to sell tickets at higher prices but without alienating their fans, and presumably without letting MLB get their percentage of the higher price.

Solution: Chicago Cubs set up another company and let that company sell the tickets at a higher price: https://sportsmockery.com/2015/07/chicago-cubs-get-caught-scalping-tickets-to-their-own-fans/

1. Price gouging harms the seller's established reputation. When I see Amazon takes raises the price of a $0.95 mask to $2 but says they are out of stock, the signal I get is a reputable established seller is out of stock. When I see "HewHaw1345" has masks on sale for $25 each, I assume he is a fly-by-night operator who found a few boxes in his basement and wants to cash in. I may buy from him if I really want a mask enough, but not only am I not going to consider buying from him in the long term, I would make it a priority to find another seller as soon as possible. Amazon and other retailers are in it for the long game, not short. The short term revenue that could be made from price gouging is smaller than the long run profits of customer loyalty.

2. In the short term price gouging laws or regulations can be helpful. When I walk into a store and see toilet paper is now being sold by the roll and is $5 each, that signals to me there's a crises afoot and I better get in on it least I'm left out. In normal times a price increase will decrease demand helping suppliers avoid shortages. In abnormal times, though, price increases increase demand by causing panic making shortages even worse.

Conversely rationing in the short term diminishes demand. When I see a sign saying the retailer will only allow two units of toilet paper per customer, I'm assured the first person in the door that morning isn't going to fill 4 carts of toilet paper and leave the store empty for everyone else. I am more likely to say I'm only going to buy if I need it at the moment.

Also 'regulatory' impact is pretty small. Many states do not even have gouging laws. A retailer like Amazon is more than capable of varying prices by state to take advantage of the difference. Many states that do only apply them to retailers in the state and make exceptions for when the retailer is simply passing along their supplier's price increases.

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