"Price Gouging" What is it?

Eight governors and several members of Congress have complained to the President about "price gouging" around distress caused by hurricane Katrina.  Gas stations sold their gas in areas starved for supply for up to $5.00 a gallon, bottled water in flooded areas went for $7.00 instead of its usual $2.00 or so.  Talk show hosts on both radio and television complain that current gas prices are price gouging.  The oil companies, they complain, are profiting on the distress of the country. 

Claims of price gouging have always been difficult for economists.  See WSJ Editorial (In Praise of Gouging), 9/7/05.  Scarcity of supply drives up prices, the price allocate who gets the scarce product, and those lucky enough to have bought supply at lower prices make huge profits on the resale.   During the gold rush, shovels at the mines went for prices that were twenty times what they went for in St. Louis. 

There are some built in market controls to gouging -- reputation.  Why do stores not mark up umbrellas whenever it rains?  Their customers do not like it, the stores loses good will, and their customers will remember and go elsewhere to buy goods if they have the option to do so. 

Several states, however, have anti-price gouging rules on their books.  See WSJ (We're For Free Market, But Not Profiteering), 9/17/05 (Gov. of Mo.)  These rules are rarely used.  This is not a surprise.  Regulation of raw price gouging is difficult to do because it is difficult to define and even if defined, enforcement of gouging rules may encourage problematic conduct.  Is price gouging an increase of 50%, 100%, or 200% in a short period of time (how short)???  Does a rule distinguish between permanent changes in supply (there is a new clearing price) and temporary changes in supply (the price will come back down when the temporary dislocation is over)??   When does profiting become profiteering??  Apparently, a little bit of gouging is fine, even admirable as capitalistic, but too much is bad and anti-social.

Moreover, If someone has product and wants to increase prices due to scarcity and the law does not let them, they may refuse to sell at the government required price.  The suppliers may either withhold product entirely until the price increases "are legal" (the price has been re-established and it is no longer a change -- gouging-- to sell at the higher price) or ship it to a jurisdiction that lets them enjoy the higher price.  Suppliers surely will not ship product in to sell it all the artificially low prices.  These incentives add to the scarcity and compounds the problem, making it worse, not better.  Remaining suppliers have enhanced incentives to cheat on the artificially low prices;  enforcement is stretched when distress means this kind of enforcement is a low priority.  Suppliers will not hoard or transport only if they believe that the local legal price in distress conditions is still higher than the prices that will be available once the conditions are over.  Local folks would be better off if suppliers did not hoard or take their supply elsewhere.  At some point the high prices will encourage suppliers to re-enter local markets;  price caps will encourage them to flee local markets.  Price caps only work, even marginally, if the supply is fixed locally, like real estate, and cannot move.

There are only two real complaints about pricing in conditions of distress:  Price-fixing and market manipulation by rumors. 

Price-fixing:  There are not enough suppliers in a given area so that those that are there fix prices with each other to raise prices to a level that would be lower (even though much higher due to scarcity) if they had to compete with each other for sales.  That is, the prices are higher than the scarcity should create.  This is the job of the FTC and the Justice Department and they are going to get into the fracas.  The problems is that the government, under tremendous political pressure, uses price-fixing allegations to penalize price gouging that is scarcity caused not conspiracy caused.  Enforcement will be random.  This aids no-one.

Market Manipulation by Rumors:  Cagey suppliers recognize conditions of panic and flood the market with false rumors of suppliers, scarcity, and distress.  The rush of customers to hoard adds to the overall supply problem and makes scarcity conditions worse than they should be.  The suppliers should be charged with ordinary market manipulation, which takes evidence of actual supplier participation in the false rumors (knowing them to be false).

Going back to the basic scarcity-caused price gouging, what is the solution?? In my view, we leave it alone unless the scarcity is in products that are critical to life and health (water).  When life is on the line, the government must step in and be a provider of last resort, distributing and contributing to the supply.  The severity of the problem dictates the severity of the government response.  The most extreme situation would require nationalization of supply and total government distribution (I hope this is only in theory); less extreme situations would require the government to sell (or donate) product in competition with private suppliers.  This is expensive but effective.  The remedy imposed the most readily by most states, price caps, is the most likely to be ineffective and even counterproductive.  It is a cheap fix that does not work.  Price caps only work in short term distress conditions when suppliers can predict with certainty that actual, market prices will come back down in the future to below the artificial price cap levels.  This is often a difficult prediction in times of distress. In short the price caps will encourage supplier hoarding in the short run and strangulation of supply in the long run.