A Little More on “Price Gouging”

In my previous post on this subject I argued that the critics of “anti price-gouging laws” are mistakenly assuming that is possible to satisfy demand at the pre-natural disaster price. That is, sadly of course, fiction. It it not our reality anymore and we are better accepting the new situation than blindly deny it. As many economists are explaining these days, to not let prices increase after a natural disaster does more harm than letting prices increase. This can easily be seen in a demand and supply graph.

Prige gouging

Consider first just the lines in black. Those lines represent the pre natural disaster situation. What is considered “normal prices”. At price p0, a quantity q0 of a good is traded in the market (i.e. bottles of water.)

Now there is a shock. A hurricane hits this region and demand increases (shifts to the right). This is the demand line in color red. The red dotted line that extends to the right shows the size of the shortage (q2 – q1) at the “normal and fair” price.

Price gouging is an emotional loaded word, but it doesn’t have any specific economic meaning. How does “price gouging” show up in this graph? It is the increase in price from p0 to p1. This is the increase in price required to satisfy the higher demand and provide the extra number of goods (q1 – q0). No… supply is not horizontal.

What happens if price increases are banned? Then at the pre-crisis quantity (q0), consumers are willing to pay p2, a price even higher than price gouging. This means two things. First, a number of people in need will be unable to acquire the goods (the empty shelf problem). Second, that the actual total cost (to those who acquire the quantity q0) is p2, not p0. The difference between the price in the store and total cost falls into waiting in long lines, visiting a long number of stores, bribing producers (yes… with natural disaster price controls also lead to black markets), calling favors., etc. Any principles of microeconomic textbook has plenty of more examples under the price ceiling discussion.

There are three scenarios being discussed here.

  1. Quantity q0 at price p0
  2. Quantity q1 at price p1
  3. Quantity q0 at price p2

The natural disaster makes scenario 1 impossible. And it is not clear that scenario 3 is better for those in need than scenario 2. Less goods are provided at a higher total cost than in scenario 2.

One final remark. Note that in this analysis the natural disaster only affected demand. Of course, it is quite likely that supply would also be affected. The point, however, is to show that prices are not pushed up only by produces. As we can see in this case, it is consumers who are increasing the price and producers reacting to the new behavior of consumers.

Advertisements

3 thoughts on “A Little More on “Price Gouging”

  1. Higher prices bring more supply as those who have the product in question can earn more if they do all they can to increase the supply of the item in question. If an increase in prices is not allowed, then there is no incentive to increase the supply of the item in question. Which means either a black market arises to sell the item in question at a much higher price, or the people in the area in question have to do without.

  2. One could also imagine that the natural disaster causes a (leftward) supply shift because: 1) the disaster destroys facilities that produce the product; 2) the disaster destroys infrastructure that facilitates delivery of the product; 3) the disaster reduces the security of private property make delivery riskier; . . .

    Including a leftward supply shift does not change the QUALITATIVE conclusions in the posted discussion; but it does make the shortage caused by an anti-price-gouging law QUANTITATIVELY larger.

Please keep it civil

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s