For my business ethics class this semester, I'm reading Michael Sandel's Justice, a review of the definitions of justice, and how various philosophers evaluate concepts such as freedom, the morally correct and incorrect, and more. The first chapter begins with a look at Hurricane Charley in 2004, and how the storm wasn't finished after the rain and clouds dissipated. With prices for necessary goods surging (Sandel cites a $40 motel room going for $160 per night and $250 generators priced at $2,000), a fierce controversy erupted on the ethics surrounding price gouging. The law quickly became involved, with some plaintiffs winning their lawsuits. As many economists have already done, I'd like to express why price gouging is beneficial, if not necessary, to the free market economy as we know it.
Before diving in, let's make sure we identify price gouging correctly. Legaldictionary.net defines price gouging:
Legaldictionary.net notes that price gouging is illegal in most jurisdictions. This is accurate: Michael Giberson of Knowledge Problem notes that 34 states and the District of Columbia have some form of legislature in place against price gouging (as of November 2012). The Federal Price Gouging Prevention Act of 2013 was introduced to the House of Representatives in 2013 to fight against unreasonably high gasoline prices, though this never became law.
Given that the government is to be the voice of the people, one may assume the people are against price gouging, no matter its economic implications. On the surface, who wouldn't fight against price gouging? I too would be furious if, after a natural disaster, I needed to purchase water for my family and was forced to pay $20 for three bottles of water that typically cost $5. What kind of rotten scumbag hikes the price of necessary goods after a natural disaster, just for profit? How could someone be so evil? The angry disbelief is palpable whenever a situation like this arises. Rather than spring boarding from the buyer's point of view, let's compare and contrast the buyer and seller in a hypothetical situation.
Suppose a massive flood has hit your town, and the waters have just recently receded. Your entire town has been devastated, with cars, homes, and businesses alike all submerged in the floodwaters. You realize you need water for your family, as well as ice, given it's summer. Making your way to an open store, you discover a bottle of water, previously $1.50, is now $10. A bag of ice, previously $4, is now $20.
Buyer's perspective: These prices are outrageous, and the store owner is nothing less than a crook for selling these necessary things at these ridiculous prices. I've already lost most of my things in this natural disaster, and now the owner wants to bankrupt me?!? I have to get these things for my family, though. You pay for the goods.
Seller's perspective: We lost a good chunk of our storage in the flood, the store is damaged, and from the looks of things we won't get a sufficient shipment of water and ice for a few days. If I keep selling these things at the regular prices, there's no way we'll be able to rebuild and repair even a fraction of this store. You sell the goods at the high prices.
It's certainly tempting to blame the seller for being a greedy pig and trying to profit off of someone's despair, but that often isn't the case (or at least the primary case). Recall the focal point of economics: supply and demand.
In a natural disaster, or some other shock to the system, the demand curve for a good will generally shift significantly to the right. This signals an increase in demand for the good, such as bottles of water and bags of ice.
Such a shift in the demand curve is depicted above, shifting from D0 to D1. Note how the new equilibrium price (where the new demand curve and the supply curve intersect) is higher up than the old equilibrium price (where D0 and S1 intersect). From a logical point of view, companies view higher demand (and higher prices) as a profit-booster. The firms boost the supply of the good or service, leading to that higher equilibrium price.
Simultaneously, in a natural disaster, the supply curve shifts to the left.
The supply curve moves from the lighter red line to the darker red line, while the demand curve (in a case where only the supply curve shifts) remains stationary. Recall that shifts in either the supply or demand curve can arise from any number of events, including a natural disaster. The supply curve shifts to the left, raising the equilibrium price and softening demand. Again, however, that is only the case if only the supply curve shifted. In our situation, the supply curve shifts left and the demand curve shifts right. The result? A relatively similar position of quantity demanded and quantity supplied, but with a higher equilibrium quantity. That result is represented somewhat below:
Shifts in the demand and supply curves simultaneously lead to a new equilibrium price in that black circle. These curves may shift to a more or less extreme degree than I have depicted here, but the general sense remains the same. In a natural disaster, or any shock that reduces supply and boosts demand, a higher equilibrium price (and thus market price) will develop. That's just economics in a free market such as ours, not the greediness of shopkeepers.
There's that phrase- free market. Let's define it using Investopedia.com:
Note the line in our definition above: "the government imposes few or no restrictions and regulations on buyers and sellers". That's the 'free' in free market- in an ideal free market, there are no price floors, no price ceilings, no taxes, no quotas, etc. Buyers and sellers are free to do their business as they please, with minimal intervention that would reduce the optimality of the market. In both Sandel's Hurricane Charley example and my own example above, the free market reigns through the higher equilibrium price as a result of the supply and demand curves shifting. Again, it's the economics of the free market at work.
What would happen if price gouging laws were in play in our above example, namely in the form of a price ceiling?
Consider the supply and demand curves here as the new curves, following the flood from our earlier example. In this area, price gouging laws prevent a market price/equilibrium price above a certain level, depicted here as the yellow line. This is a price ceiling. As we did earlier, let's view this new scenario from a buyer's perspective and a seller's perspective.
Buyer's perspective: Good thing those price gouging laws are in effect, now I'll be able to buy the bottled water and bags of ice for my family. Wait, the store is sold out? How could it be?? You say someone bought all the water and ice earlier?!? You cannot buy the goods due to a shortage.
Seller's perspective: I can't believe all of the water and ice was sold out in under an hour. There's at least 50 people here demanding more water and ice, but there's just no more. Adding to that, thanks to these price gouging laws, I had to take losses on selling the ice and water. You cannot sell the goods due to excess demand and losses incurred.
In our new scenario, with a price ceiling acting as a price gouging prevention device, a shortage in water and ice bags quickly emerges. At this lower price, as shown in the graph above, demand far exceeds the amount supplied. In a free market without any natural disasters, supply is well below demand because the price level of the price ceiling is too low for the firm to make a profit. To minimize losses, firms supply less. Consumers see this as a bargain, and demand more. However, lower supply in the face of higher demand results in a large shortage. This is no longer a free market economy.
An interesting point was brought up in Sandel's book. In defense of price gouging in the wake of a natural disaster, pro-market writer Jeff Jacoby pointed out how the higher equilibrium price of these goods acts as an incentive for suppliers to produce more of the good. Indeed, a price ceiling provides no incentive for a firm to produce more of a good- they would just incur losses, after all. By permitting higher market prices of goods following disasters such as a hurricane or flood, suppliers are far more willing to increase supply of these goods than if price gouging laws were in place. In the short term, higher prices spells financial pain; this is true. In the longer term, however, increased supply of necessary goods like ice bags and water speeds the recovery of areas hurt in natural disasters.
I've found the above proverb to be a particularly interesting one. It is often applicable in real life situations, but also realistic in hypothetical situations. In terms of price gouging, it is also quite applicable: The enemy (free-market economy) of my enemy (price gouging) is my friend. Perhaps a little simplistic, but it holds true nevertheless. So long as we permit buyers and sellers to freely find market prices, even in extreme situations like after natural disasters, the most efficient outcome will prevail.
In summary, the higher prices of necessary goods in the aftermath of natural disasters is beneficial and crucial to the structure of our free market economy. Allowing higher prices incentivizes suppliers to provide more of the necessary goods, eventually allowing the market price to move lower again. Enforcing laws to prevent price gouging, particularly through the use of a price ceiling, results in shortages of these necessary goods for buyers, and incurred losses for sellers. In order to provide the most efficient outcome in the end, and maintain the integrity of the capitalist economy, allowance of higher prices in extreme situations is required.
Before diving in, let's make sure we identify price gouging correctly. Legaldictionary.net defines price gouging:
"Price gouging is a term that refers to the practice of raising the price of goods, services, or commodities, to an unreasonable or unfair level. Such an increase in price is often a result of a sudden increase of demand and shortage of goods, such as in the event of a natural disaster or other crisis, and it is illegal in most jurisdictions."In sum, we'll define price gouging as raising the price of goods, services, and commodities to unreasonably high levels, brought on by sudden demand or supply shocks.
Legaldictionary.net notes that price gouging is illegal in most jurisdictions. This is accurate: Michael Giberson of Knowledge Problem notes that 34 states and the District of Columbia have some form of legislature in place against price gouging (as of November 2012). The Federal Price Gouging Prevention Act of 2013 was introduced to the House of Representatives in 2013 to fight against unreasonably high gasoline prices, though this never became law.
Given that the government is to be the voice of the people, one may assume the people are against price gouging, no matter its economic implications. On the surface, who wouldn't fight against price gouging? I too would be furious if, after a natural disaster, I needed to purchase water for my family and was forced to pay $20 for three bottles of water that typically cost $5. What kind of rotten scumbag hikes the price of necessary goods after a natural disaster, just for profit? How could someone be so evil? The angry disbelief is palpable whenever a situation like this arises. Rather than spring boarding from the buyer's point of view, let's compare and contrast the buyer and seller in a hypothetical situation.
Suppose a massive flood has hit your town, and the waters have just recently receded. Your entire town has been devastated, with cars, homes, and businesses alike all submerged in the floodwaters. You realize you need water for your family, as well as ice, given it's summer. Making your way to an open store, you discover a bottle of water, previously $1.50, is now $10. A bag of ice, previously $4, is now $20.
Buyer's perspective: These prices are outrageous, and the store owner is nothing less than a crook for selling these necessary things at these ridiculous prices. I've already lost most of my things in this natural disaster, and now the owner wants to bankrupt me?!? I have to get these things for my family, though. You pay for the goods.
Seller's perspective: We lost a good chunk of our storage in the flood, the store is damaged, and from the looks of things we won't get a sufficient shipment of water and ice for a few days. If I keep selling these things at the regular prices, there's no way we'll be able to rebuild and repair even a fraction of this store. You sell the goods at the high prices.
It's certainly tempting to blame the seller for being a greedy pig and trying to profit off of someone's despair, but that often isn't the case (or at least the primary case). Recall the focal point of economics: supply and demand.
In a natural disaster, or some other shock to the system, the demand curve for a good will generally shift significantly to the right. This signals an increase in demand for the good, such as bottles of water and bags of ice.
Simultaneously, in a natural disaster, the supply curve shifts to the left.
There's that phrase- free market. Let's define it using Investopedia.com:
"Free market refers to an economy where the government imposes few or no restrictions and regulations on buyers and sellers. In a free market, participants determine what products are produced, how, when and where they are made, to whom they are offered, and at what price—all based on supply and demand."Free markets go hand in hand with capitalism: free market is a key concept of capitalism, to be precise. The United States is a capitalist economy, there is little doubt of that. As buyers and sellers, we collectively determine market prices, and buy and sell accordingly.
Note the line in our definition above: "the government imposes few or no restrictions and regulations on buyers and sellers". That's the 'free' in free market- in an ideal free market, there are no price floors, no price ceilings, no taxes, no quotas, etc. Buyers and sellers are free to do their business as they please, with minimal intervention that would reduce the optimality of the market. In both Sandel's Hurricane Charley example and my own example above, the free market reigns through the higher equilibrium price as a result of the supply and demand curves shifting. Again, it's the economics of the free market at work.
What would happen if price gouging laws were in play in our above example, namely in the form of a price ceiling?
Buyer's perspective: Good thing those price gouging laws are in effect, now I'll be able to buy the bottled water and bags of ice for my family. Wait, the store is sold out? How could it be?? You say someone bought all the water and ice earlier?!? You cannot buy the goods due to a shortage.
Seller's perspective: I can't believe all of the water and ice was sold out in under an hour. There's at least 50 people here demanding more water and ice, but there's just no more. Adding to that, thanks to these price gouging laws, I had to take losses on selling the ice and water. You cannot sell the goods due to excess demand and losses incurred.
In our new scenario, with a price ceiling acting as a price gouging prevention device, a shortage in water and ice bags quickly emerges. At this lower price, as shown in the graph above, demand far exceeds the amount supplied. In a free market without any natural disasters, supply is well below demand because the price level of the price ceiling is too low for the firm to make a profit. To minimize losses, firms supply less. Consumers see this as a bargain, and demand more. However, lower supply in the face of higher demand results in a large shortage. This is no longer a free market economy.
An interesting point was brought up in Sandel's book. In defense of price gouging in the wake of a natural disaster, pro-market writer Jeff Jacoby pointed out how the higher equilibrium price of these goods acts as an incentive for suppliers to produce more of the good. Indeed, a price ceiling provides no incentive for a firm to produce more of a good- they would just incur losses, after all. By permitting higher market prices of goods following disasters such as a hurricane or flood, suppliers are far more willing to increase supply of these goods than if price gouging laws were in place. In the short term, higher prices spells financial pain; this is true. In the longer term, however, increased supply of necessary goods like ice bags and water speeds the recovery of areas hurt in natural disasters.
"The enemy of my enemy is my friend."
I've found the above proverb to be a particularly interesting one. It is often applicable in real life situations, but also realistic in hypothetical situations. In terms of price gouging, it is also quite applicable: The enemy (free-market economy) of my enemy (price gouging) is my friend. Perhaps a little simplistic, but it holds true nevertheless. So long as we permit buyers and sellers to freely find market prices, even in extreme situations like after natural disasters, the most efficient outcome will prevail.
In summary, the higher prices of necessary goods in the aftermath of natural disasters is beneficial and crucial to the structure of our free market economy. Allowing higher prices incentivizes suppliers to provide more of the necessary goods, eventually allowing the market price to move lower again. Enforcing laws to prevent price gouging, particularly through the use of a price ceiling, results in shortages of these necessary goods for buyers, and incurred losses for sellers. In order to provide the most efficient outcome in the end, and maintain the integrity of the capitalist economy, allowance of higher prices in extreme situations is required.
