There’s an old vaudeville gag where a man asks a butcher for pork chops. The butcher says they’re $2.50/pound. (It’s a very old joke.)
“That’s outrageous!,” the man exclaims. “The butcher down the street only charges $2.00”
“So why don’t you buy from him?” the butcher asks.
“He’s out of pork chops,” the man admits.
“Well,” says the butcher, “when I’m out of pork chops I sell them for $1.00”
This is why price gouging is a good thing.
During Hurricane Matthew, officials sometimes seemed more concerned with “price gouging” than with the storm. Florida set up a price gouging hotline and so far has thousands of complaints. Thirteen states already have some sort of anti-price gouging law on the books. So it looks like the citizens are really being protected from those greedy merchants, right?
Not really. Fear of being accused, and maybe prosecuted for price gouging guarantees there will be a shortage of critical supplies when they are most needed. Here’s why;
Let’s take gasoline, but this applies to almost any product. When you pay for a product, the merchant doesn’t get to keep much of the money. Most of the price a merchant charges gets spent on ordering replenishment stocks of what was sold. This enables a steady restocking of the products that are sold so the gas tanks, or the shelves in a store are always full. This works fine so long as the demand stays more or less constant. But what happens when there is a sudden big jump in demand? What happens if instead of selling 1000 gallons of gas a day there’s a hurricane and the merchant suddenly encounters a demand for 3,000 gallons ? So he just orders more, right? Sure but with what? At 1,000 gallons he has the money to reorder another 1,000 gallons or so to replenish, but not enough to suddenly have three times that much. The result is that once the thousand gallons are gone, nobody gets gas until the regular gas truck shows up at the end of the week. Then that 1,000 gallons/day gets quickly bought up and the people who got there late are up the creek.
But hey, nobody got price gouged, so it’s all good.
Now let’s say the merchant is allowed to “Price gouge”. He raises the price of a gallon from around $2/gallon to say $5/gallon. Outrageous, right? Not so fast. That price gouging makes some very good things happen.
First, higher prices increase supplies. The merchant can now order greatly increased supplies of gas to satisfy the new demand. It is unlikely his normal supplier can come up with three times as much gas on short notice, so this will probably mean ordering the extra supplies from other suppliers who are more expensive because they are farther away, or less efficient. They would never be able to supply the needed extra gas the customers suddenly need at the “ungouged” price, but would at a higher price. They might even be willing to divert stockpiled gas to the station to take advantage of the higher price.
Second, high prices serve to ration demand. The higher price will cause people to conserve. They will purchase only what they need. We’ve all seen people pull up to a pump during a shortage and fill the tank, then break out several five gallon cans and fill them as well, “just in case”, leaving less for the next guy. That would happen far less with price gouging and would ease the demand, because people would buy only what they really need.
Third, the extra money might make it possible for the merchant to purchase a generator as an additional emergency measure to keep the gas flowing during power failures. This was a big problem after Hurricane Matthew. Cars were running out of gas in traffic jams because no gas stations had electricity to run the pumps. But at least they didn’t price gouge.
The bottom line is that the higher price means that everyone will get gas at $5/ gallon instead of only a third getting it at $2/gallon and everyone else getting nothing.
So three cheers for price gouging. I would rather pay $5/gallon to get gas I desperately need than to have no gas available but know that it would be cheaper if it was. If I can’t get those $2 pork chops, I’ll take the ones for $2.50 rather than go hungry.
(BTW, most so-called price gouging is far less than the magnitude shown in the example, and whatever it is, the prices will come back down with demand after the crisis is passed.)