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Monday, September 12, 2005

Price Gouging: Back By Popular Request

Commentators at the Conglomerate are engaged in a great debate about the wisdom (or, perhaps, sad inadequacy) of a recent of mine post here on the rationality of anti-price gouging regulations ("PGRs"). 

Surprisingly, some seem to think PGRs are straight-forward "price controls" like those prevailing in the mercifully defunct "Soviet" system.  Not quite.  Instead, most PGRs have four distinctive characteristics: (1) a time-limited "emergency" must be declared; (2) the selling price must "grossly" or "unconscionably" exceed the reference (normal) price; (3) the change in price must be unjustified by supply cost changes; and (4) the remedy is a later court determination that the differential violated the standard.  See, e.g., Florida, Georgia, Pennsylvania (through its little-FTC act), and a summary here.  In short, PGRs are short-term, dynamic, market-based standards that are applied retroactively.

Taking these limitations seriously makes us realize that PGRs look a great deal like antitrust regulations - having their bite when local suppliers suddenly have the ability (through no innate ability, foresight, or skill) to raise prices without fear of new competition coming in (because of the civil emergency.)  Joshua Wright observes here that the "[t]he increase in price is not a function of the elimination of competition such that there is now a seller of necessary goods with monopoly power. The increase is due to a change in supply conditions faced by all competing sellers."  But that seems wrong, at least with respect to those increases in price that PGRs will actually punish.  The reason that suppliers get punished is that they raise their prices beyond that needed by required by the condition; the reason that they can do this must be because the market is distorted in some way.  All of which is to say that I think it best to see PGRs as acting to reduce artificial and evanescent monopolies.  Compare this article which finds that price decreases following emergencies are slower than we would predict with this article collecting stories of post-September 11 price increases apparently unrelated to supply problems.

In any event, I originally claimed that PGRs ought to have similar effects as high prices on consumers (encouraging lower demand) while being "more satisfactory" than price gouging.  Why is this?  Here, I think we need to discard the classic gas station model and turn to alternative stories of price gouging.  (The gas station story is a hard case for PGRs: (1) multiple suppliers; (2) demand can be somewhat elastic; (3) real supply interruptions.)

How about the hotel problem?  Recall the story: there is one hotel in town; individuals can't or won't travel elsewhere (perhaps due to closing of borders between towns); the hotel's costs have gone up slightly (fuel/transportation of food); citizens who do not leave their homes are likely to face severe inconvenience (power loss, etc.) as well as threat of serious bodily harm. 

Now, the hotel increases costs between two and three times the reference price.

I just can't see how marketeers get over the wealth effects problem that accompanies the anti-PGRs solution to this particular example. The only response that I've seen is that government ought to (instead of enforcing PGRs) distribute subsidies to the poor. PGRs, by contrast, tend to force suppliers of shelter to distribute it on a first-come, first-served basis.  When PGRs are implemented (recall: the state must declare an emergency), individuals are surely  informed of the relevant supply/demand imbalance.  So, we would predict that PGRs result in the shelter being given to the folks who call the hotel first, instead of those who can pay the most.  Sounds good to me.

I reject the argument that I need empirical evidence to raise these issues, or that lack of evidence makes my arguments "fantasies" or "counter-intuitive, counter-theoretical, and counter- common-knowledge claims."   First, I agree with Scott Moss:

[I]t is an unanswered empirical question whether, in the peculiar circumstances of any particular emergency, (a) the dis-incentive effect of price controls outweighs (b) the positives of limiting inefficiently high prices. (As to (b): prices would come down eventually, without controls, if they truly were "inefficiently high" -- but "eventually" may not be good enough in an emergency situation.) In short, I'm dubious that we can rely solely on first principles to answer the question, "should there be price controls in this particular local emergency situation?"

Moreover, I think that given the distributive consequences of recalling PGRs, the first question about the world we should be asking is directed toward those who advocate reform.  That question is: has any state ever changed its tax and transfer system to ameliorate the wealth effects that accompany repealing PGRs?  I have found no examples. 

As Brad DeLong notes, a second benefit of PGRs is psychological: it satisfied our need to believe in the inherent fairness of the market economy.  This fits nicely with the BLE model of price gouging (discussed in this well-known paper.) Improved faith in the fairness of legal economic exchanges redounds to the economy's benefit in the long run. 

This brings to mind a third type of reason why PGRs are more satisfactory than allowing high prices: PGRs protect suppliers from their own short-term thinking.

For those that believe that corporate managers sometimes  make irrational decisions, there is a story here about the hotel managers deciding to engross every cent possible (a certain present gain) instead of the uncertain future gain that would accompany keeping the good will of the local community.  For more on this, read Jeffrey J. Rachlinski, Gains, Losses, and the Psychology of Litigation, 70 S. CAL. L. REV. 113 (1996).   Assuming this is true: why doesn't price gouging happen all the time? Perhaps it is the shadow of PGRs that help managers to confront the irrationality of price gouging by making them consider if their price increases are "unconscionable" or "grossly disproportionate".  For many managers, no doubt, such deliberations will lead to the following question: "How will the community judge me in a month?"  The outcome of this deliberation is good for the manager, and, for different reasons, good for his poorer customers.  (I acknowledge that thinking of PGRs as a helping potential price gougers is somewhat odd.)

This  insight - for what it is worth - leads to a testable prediction: retail gas stations in states with PGRs ought to be rewarded by higher customer goodwill and loyalty. 

Perhaps an inspired commentator will step up with the data.

Posted by Dave Hoffman on September 12, 2005 at 12:30 PM in Current Affairs, Law and Politics, Legal Theory, Torts | Permalink

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Here's a partially-baked thought on this debate.

While I believe in the strong efficiency of the price mechanism in 99.9% of cases, the floodzone gasoline example might be in the 0.1% of cases where you have a localized, temporary shortage and price may not be
(A) signalling scarcity and filtering highest, best use so much as
(B) reflecting panic demand, particularly by those utterly and literally path dependent on internal combustion.

I wonder whether the people who disagree with you believe we have a housing bubble, and if they do, whether they believe there's any state role to manage that.

In both the gasoline and real estate examples, the state has had a strong role in getting us to our currently inefficient equilibrium. I'm not sure that knee-jerk Hayekian faith in price theory /always/ makes an inefficient situation better, if you're just moving to another inefficient situation.

This concern would be greater, in my mind, when information costs are
extreme (evacuation panic). This argument may prove too much, though.

Posted by: Salil Mehra | Sep 12, 2005 1:26:53 PM

I am not sure what is wrong about my statement that the price increases we are talking about are not caused by a sudden onset of monopoly power. Actually, I thought point #2 of your original post was that markets dont clear in emergencies. I may have misunderstood that post. What I take to be the newer monopoly claim is that markets do clear, but result in deadweight loss.

From an economic perspective, calling this monopoly power is incorrect. Monopoly power involves the ability to artificially reduce market output below competitive levels. By way of comparison, the scarcity taking place here is quite real. The phenomenon is quite different than monopoly power: the number of competitors in the local markets (which were presumably competitive pre-Katrina) did not change, it does not appear that any single supplier became more powerful at the expense of others. Your claim seems to be that monopoly power that did not exist before Katrina exists afterwards for all suppliers. This cant be right.

Where there are plenty of suppliers, this seems implausible for obvious reasons. It takes a seller with sufficient control of the market output to unilaterally reduce that output. All of them cannot have this power. You could be claiming that the exercise of monopoly power is the result of collusion between the sellers. Nobody has mentioned collusion or price-fixing yet, so I assume the claim here is the former and not the latter. But collusion violates the antitrust laws without a PGR, and is worthy of condemnation especially in the wake of a hurricane. For the reasons stated above, I do not believe this makes sense. It is quite clear that the price increases are the function of economic phenomenon unrelated to monopoly power.

Two comments about the law. First, there is one important difference between the PGRs and antitrust violations. The antitrust laws only condemn "the willful acquisition or maintenance of that power as distinguished from growth or development as a consequence of a superior product, business acumen, or historical accident." It is quite unremarkable to note that the historical accident exception would apply here. The PGR statutes, therefore, go well beyond the conventional domain of antitrust regulation.

Second, Dave mentions that the PGRs will only punish those that increase prices in a manner not justified by the cost increase, and that price increases result because "the market is distorted in some way." I have trouble with the first statement and agree (kind of) with the second. The market is either competitive, or it is not. If the market is competitive, I am skeptical that suppliers will be able to increase prices in a monopolistic fashion without collusion. I am even more troubled by the notion that a court will determine the line between cost-justified pricing and otherwise. And as I stated, we dont need PGRs to go after price-fixers.

Finally, if you want to call changes in supply or demand conditions "distortions," I am certainly willing to agree with the proposition that the upward movement towards the new market-clearing price results from one of those. I am not sure how this helps to prove that monopoly power exists. This discussion reminds me of Coase's comment that "if an economist finds something -- a business practice of one sort or another -- that he does not understand, he looks for a monopoly explanation." There are certainly economic phenomena involved in the price increases here, but it isnt monopoly power.

Posted by: Joshua Wright | Sep 12, 2005 2:13:17 PM

Joshua: Apt quote! I'll think some more about your comment and respond further in a few days.

Posted by: Dave Hoffman | Sep 12, 2005 6:05:56 PM

"Price Gouging" laws, like all laws which imposes price controls, prevent the proper functioning of the market. Even adding the weasel words will merely increase the price of and demand for the services of attorneys, rather than mitigating the damage done by the law.

Of course the classic case of price gouging is the guy selling bottled water in a disaster area. There may be some people who are just "lucky" in that they ended up in a disaster area with a large stock of bottled water. Then again, even if they just happen to own a store which just happens to be located in a disaster area, they might ask themselves if they want to go into work and sell that water, or if they would prefer to stay home and lick their own wounds. This decision is, of course, complicated by the physical risks of showing up at work during a disaster, the added difficulty of working in a disaster, and the competing demands that may be placed on the individuals time in a disaster. So the question is, do we

(a) force the individual at gunpoint to go to work
(b) allow him to charge that price which causes him to go to work voluntarily.

Of course, once the individual is AT work, he has a limited quantity of stock. If he sells his water at the normal price, or even double or triple the normal price, he may well find that people are coming in and buying large quantities of water, and suspect that if his prices stay at the current level, he will run out of stock. If he raises his price, he will not only slow down the shortage, but he will also suddenly have incentive to convince his unemployed cousin with a pickup truck to drive from Miami to Tampa, buy water retail, and truck it back to Miami. He will also have the money to pay for his cousin's time, gas and the cost of the water.

But the unemployed cousin gambit works both ways. Personally, if I am ever in Miami when there is a hurricane, I want every unemployed individual in the state to load up their pickup trucks, buy water at their local gas station, drive to Miami (as close to me as possible), and sell it on the street at the highest price they can get ... hopefully, this will be a price so high that they find themselves inspired to make another trip.

What I also want is for each shopkeeper in my area to put aside some cases of water, among other things, in order to sell at outrageous prices (e.g. prices that cover the cost of long term storage). And I want him to make so much money off the first hurricane that he stocks twice as much for the second.

Even in the case of the hotel, the proprietor may well find that he can build two or three extra rooms, beyond the optimal profit point (without considering disasters), if he knows that he can get killer prices for those rooms in a disaster. And I want those extra hotel rooms to be built.

-------

As for the "housing bubble", of course we have one, and the government certainly had a role in it. The government printed fiat money like it was going out of style, and dumped it on the banks, in order to create the illusion of prosperity, and in the hope that consumers would be to dim to notice the inflation. When they do this, it invariably causes malinvestment, which is usually in the form of some sort of "asset bubble". This is why we had the dot com boom and bust, and why we had the housing bubble and bust. It is also why we had the roaring twenties and the great depression. It is a very old story.

It never ceases to amaze me that it never ceases to amaze people that saving is at an all time low, and debt at an all time high, when during parts of Greenspan's term at the fed we actually had negative real interest rates ... that is, the rate of interest was lower than the rate of inflation. One would, of course, have to be insane to save money under such conditions, and people did not. What a shock. Instead, they borrowed money, and expected to pay it back with much smaller dollars later. And if the rates of inflation and interest were fixed at what they were when they did it, those decisions would have been rational.

If you want to stop having a business cycle, and asset bubbles, you need to eliminate fractional reserve banking (which creates phantom money and real inflation) and fiat money (which creates fake money and real inflation).

see: http://mises.org/

Posted by: Rich Paul | Nov 8, 2007 12:41:56 AM

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