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Price Gouging Is Good – Here’s Why

by Darwin on September 16, 2010

I was thinking about the economics of price gouging the other day when Hurricane Earl came to town, when in typical fashion, people were behaving as though the Apocalypse were upon us and they were buying anything and everything in site at the grocery stores.  This is pretty common prior to our massive 3″ snowstorms we get in the northeast as well since the local news does everything possible to hype any precipitation as the “Storm of the Century” when more often than not, it’s just a nuisance.  Regardless, this got me thinking about how beneficial it would be if stores did gouge.

Price Gouging is Good

Sure, call me the Gordon Gecko of economics, but seriously, gouging is simply free markets at work.  Remember during Hurricane Katrina how inept and unprepared our federal government response was?  It was so bad that nobody really had anything – for weeks.  So, an enterprising guy thought up the idea to both help the residents in affected areas, and himself, and he rented a truck, bought a bunch of generators and went down there to sell the generators at a hefty profit.  Let me repeat:

  • He had an idea.
  • He invested his own capital and took the risk of loss
  • He expended his time and efforts to sell these much-needed generators
  • He provided people an option where none previously existed
  • He made a profit
  • He was arrested

Of course, the press, and then, politicians jumped all over this and crucified the guy.  But wait a minute!  These people weren’t FORCED to buy his generators.  And he was their ONLY option since retailers had stocked out (because they didn’t gouge) and the federal government response was sadly inadequate.  So, he had a solution, and for a fair market price (you can question the fairness of jacking up the price, but since people were paying, obviously it was market-priced), he provided people with something they needed desperately.

People generally frown upon gouging and think those who gouge are evil charlatans.  But gouging serves an important task in really forcing rationing of goods and services to those who really need it.

Here’s a real-world example:A big hurricane is on its way

  • A major hurricane is coming
  • People flock to the stores and wipe everything off the shelves
  • The first couple people to the store clean out the entire inventory of bottled water
  • Since the store didn’t raise the price on anything, the calculus was that they’ll eventually drink the water anyway, so why not?
  • The hurricane turns out to be really bad and people lose power and water
  • Hundreds of people run out of water while the systems are repaired
  • Much panic and despair ensues; people have no clean drinking water
  • The jerks who bought all the water go through their 2 days worth during the outage and are sitting on another 2 months of water supply
  • They consider selling their excess water for a profit but opt not to for fear or prosecution

This could have gone much differently.  If the store had raised the price of the water in anticipation of the heavy storm, people would really think about just how much they should buy.  Was it really worth buying months of water at INFLATED prices when it was extremely unlikely that an outage would exceed a day or two?  Of course not!  So, they’d buy a couple days’ worth and dozens of other families would get some of the water they needed, albeit at an inflated price.  This is a completely simplistic example, but it translates into real-world economic problems. I guess with some tips for selling online in a quick and safe manner, this could even be scaled up for certain circumstances.

We encountered this problem with the gas lines in the 1970s when the government forced an artificially low gas price as opposed to letting it spike further.  We also see this in rent-controlled areas like NYC where the real estate is out of control.  The examples abound, and time after time, it’s evident to those who really look at it that gouging is good – it balances real need with price and supply, as opposed to rewarding artificial floors on pricing.  But I’m curious what you think.

Should Price Gouging Be Illegal?

{ 6 comments… read them below or add one }

Kevin@InvestItWisely September 16, 2010 at 12:57 pm

Nobody likes a price gouger, although all voluntary trades make both parties better off, and without the gouger, people wouldn’t have those supplies.

The problem is, let’s say the scenario was one of life or death. Is a person justified in charging someone else $1000 to say, give them a gallon of water? This clearly seems like exploitation to most of us, although it is the person’s only way to survive.

I think there’s a line between price gouging and exploitation where the gougers will face immense ostracism and the would-be purchasers will simply rob him instead, so there is always a balance there. In general, these factors balance out and there is nothing wrong with people paying a premium in order to compensate the risk and expense of that guy bringing in those supplies in the first place!

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Darwin September 18, 2010 at 10:32 am

The thing about the hypothetical “life and death” example has the following problem though. If someone’s dying of thirst, outside of even considering the gouging issue, is it moral to charge someone even the going market rate before the emergency? You’d just give them the water regardless, right? So, it’s not a gouging issue, but a moral issue. Now, if you think about it, a situation where there’s a shortage of water would actually be much LESS likely to have even occurred if stores were able to raise their prices in advance of the storm! … because people wouldn’t have hoarded and would have only bought a few days’ water instead of clearing the shelves.

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Kevin September 18, 2010 at 3:37 pm

Yep, you have to look at the unseen consequences of actions as well. They are less visible, but no less real.

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Budgeting in the Fun Stuff September 17, 2010 at 9:11 pm

I can’t believe the guy selling generators was arrested! During Hurricane Ike, a ton of people sold generators for outrageus sums of money and nobody complained. We simply chose to laugh at the price and didn’t buy one, but why should it be against the law? Like you said, nobody was making those people buy the generators!

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Darwin September 18, 2010 at 10:33 am

The politicians pushing prosecution thought they were scoring points, but the reality is, come next emergency…no help from citizens. Govt can botch the job again and people will suffer. All in the name of anti-gouging laws.

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Khaleef @ KNS Financial September 18, 2010 at 11:48 am

I didn’t hear about the guy with the generators…that’s crazy! I can’t believe he was arrested for providing something at a price that some were willing to pay!

I like the fact that you looked at this from the store’s point of view. You’re right, if they were able to gouge, then their supplies would remain for much longer – although you would have some who honestly couldn’t afford those prices. They would be forced to go without if the government response is inadequate.

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