Is Price Gouging Good? / by Todd Yarbrough

As it does, the conversation surrounding the efficacy of price-gouging pops up every time there is a serious natural disaster which causes shortages of necessary products (generators, water, clothes, food, etc.) and subsequently causes prices of the products to rise considerably. On one side of this conversation are free-market adherents, who principally believe that price hikes before and after natural disasters are just natural market forces equilibrating the market under disaster conditions. To them, it's not price gouging, but simple supply and demand. On the other side are those more weary of free-markets, who principally believe that price hikes before and after disasters are another sign that markets are not always the best way to organize economic movement. To them, supply and demand is a fickle master blind to equity and moral considerations.

So, who's right? Let's first consider why prices rise considerably after a natural disaster: a negative supply shock at the same time as a positive demand shock. For example, generators will be supplied by fewer stores as supplies run out (some stores being destroyed and shipments being slowed) but simultaneously will be demanded by more folks (as most folks don't find it necessary to have generators during non-disasters). This 1-2 punch causes the price to rise significantly. 

So, what are the good things about letting the market push the price up? Well, since there will be a crimp on the future supply of generators, allowing the price to rise will reflect the fact that suppliers are also likely facing higher prices, so the market pushing the price up will help suppliers of generators not lose money. So, the good thing is that a higher priced generator still incentivizes suppliers to bring them to market, despite the arduousness of doing so before and during a natural disaster. This ensures that at least some folks will have access to purchase generators, which is better than zero. 

What about the bad? Well, any existing inequity is made worse by rapidly increasing prices. So, low income and fixed income folks are disproportionately impacted by the rapid rise in generator prices. Further, since generators will be more expensive, a low income person may be more likely to shop around, spending even more of their own time trying to locate a generator during the precious hours before an impending natural disaster. Even further, low income folks are also likely to need a generator more than high income folks who have more options to ride out a storm. So, if low income folks are excluded from the market either due to cost or access, then this is bad from a social utility perspective.  

I think the crux of the issue lies in the distribution of both pre-disaster and post-disaster generators, or any other post disaster need. The fact is that even before an impending disaster puts upward pressure on prices, many low income folks simply cannot afford a generator. And if they live in areas which are prone to needing generators, we may view this as a market failure, fixable by simply subsidizing the purchase of generators for low income folks. Again, the price hike will allow suppliers to still profitably bring generators to market, but the additional burden of the price hike, as does any price hike, will fall on those most vulnerable.

Price controls are historically poor ways to help low income folks take part in markets, and in this case will likely cause an even greater shortage of generators and may even lead to exploitative arbitrage on the part of folks who buy up a bunch of cheap price controlled generators and then sell them on the secondary market to folks in need. Better those generators pass through the market naturally along with the price hike, and the government step in to provide financial assistance to low income folks who incur costs to keep themselves alive during and after natural disasters. 

In my mind the question of "is price-gouging good?" is the wrong question to ask. What we should ask is to what extent should the government subsidize disaster preparedness for low income folks? Many states in disaster prone areas have tax holidays for disaster preparation products, like generators. While these holidays are a small subsidization and have their heart in the right place, they are not likely to do the job that a direct subsidy would. 

Further Reading:

https://www.forbes.com/forbes/welcome/?toURL=https://www.forbes.com/sites/jeffreydorfman/2016/09/23/price-gouging-laws-are-good-politics-but-bad-economics/

https://qz.com/1063188/hurricane-harvey-banning-price-gouging-is-bad-economics/

http://www.npr.org/sections/money/2012/10/29/163861383/why-economists-love-price-gouging-and-why-its-so-rare

https://hbr.org/2013/07/the-problem-with-price-gouging-laws