Wednesday, September 10, 2008

Price gouging for dummies

Next time you see someone from the ACCC, tell them to keep their filthy socialist mitts off our free markets.

The Mises institute has a funny-because-its-true summary of what happens when these ambiguous "price gouging laws" are used to prosecute traders. You fill in the blanks:


Price controls and price-gouging laws make matters worse rather than better.

Consider the case of (hapless merchant) , who was fined $___ and sentenced to ___(months/years) in jail for increasing the price of (goods) by ___%.

The bitter irony is that (merchant) 's (goods) were conf
iscated and taken to a secure location, where they (rotted/melted/remain to this day) .

The citizens of (town) are still without (goods) , and the very person who tried to provide them with (goods) faces prosecution.


This is indeed the way things work. Are price gouging laws really moral and ethical ?

Firstly, no matter how you spin it, the law has one primary functi
on - to prosecute people who try to sell something.

Of course, they set their own prices in this process, but they do not attempt to use coercion or violence to force any buyer to engage in the transaction.

And yes, it becomes a very sensitive and emotional issue in
the wake of a disaster. Even the act of engaging in voluntary trade becomes something that people cast strong judgements about, because the trade involves highly desirable goods that relate to people's survival - i.e bread, fuel, water, candles.

Secondly, from an ethical and moral viewpoint, what is the best way for a trader to allocate and distribute these highly desirable goods in an emergency ?

  1. Keep prices the same causing massive lines and shortages. ?
  2. Push prices down, or even make these desirable goods completely free ?
  3. The free market solution - Adjust prices upwards sufficiently so that supply meets demand, and people do not queue up for these goods and no shortage emerges ?

Well, I'll now try to show why #3 is always the most ethical and moral solution to allocating scarce goods to customers.

This analysis applies strictly to these essential goods that cause so much emotional attachment during an emergency.

In this scenario, the demand curve has gone up by a huge amount, which means that the price each customer is wil
ling to pay, and thus the value attached to that good or service has increased by a large amount.

The supply curve has not moved one bit. During the very initial stages, supply can not be expanded. You can not wave a wand and have extra fuel, food or bread on the spot. Up till now, nothing I have said is very controversial. Its just pure reality. This is what happens for the market for essential goods and services during emergencies.

Its how we proceed from here, that is so hotly disputed.

The demand curve represents the people in the market, and the aggregate of what each individual is willing to pay. When you sum them up, you get a curve which shows how much or how many units of a particular good will be purchased at a particular price.

If prices are held constant, or even worse, if they are lowered, a shortage will and must occur.

Options #1 and #2 always involve massive queues, mobs and even stampeding crowds. Shortages mean that the shelves run empty. Shortages mean that the first in ( or those who push most aggressively and trample over others to be the first in) are the ones who get rewarded.

Free markets would allow prices to adjust upwards to the point where supply meets demand.
But government regulations and price gouging laws do not. So I shall call any price, below this intersection, the government price.

At the government price, there will be people who were willing to pay the going price for the goods but did not manage to secure it. This is exactly what is meant by a shortage.

Whats more, those who were first in (the fittest, the most patient and prepared) are not necessarily the people who valued the goods the most highly. Take the example of medication - imagine a queue forming and the shelves of a chemist being emptied within hours.

If somebody was willing to trade their house for medication to survive, then they may be forced to do just that to buy the medication off somebody who managed to beat the queue and secure it. This all happens because traders were not allowed to adjust their prices upwards by even 10% or else they could be prosecuted by the gov't.

A whole new speculative market emerges where people rush to secure these essential goods because they know that you cannot deny the forces of the free market. They know that these essential goods can be re-sold to those most desperate for a quick and easy profit. Perhaps this form of profiteering is deeply offensive and upsetting to people, but in the end, it is a form of voluntary trade and it is better to allow the essential goods to find their way to those who place the greatest value on it.

In times of emergency, if option #1 or #2 is implemented, then a speculative market builds overnight. People queue up for groceries and petrol because they can see that a shortage will emerge at the artificially low prices. These individuals are not necessarily the ones who value these scarce goods the most highly, but those who are quick and can calculate that there are other people who will place a value on those items that is much higher than the going price.

By regulating the prices that shops and traders can charge for goods and services, you are trying to plug your finger in a hole when the boat is leaking. The market forces will emerge through a different hole. It is better to allow the free market to adjust prices in the first place so that people can visit the stores and pay more for the goods they so desperately need, and so that people who do not need the goods at the higher prices will not buy them.

We are led to the obvious conclusion - Option #3 does the least harm. It is the most moral and ethical. And what of the benefits ?

Well Option #3 allows prices to adjust upwards. Everybody should be aware that prices are a big big signal, a red flag to other producers. It sends out a HUGE incentive to other producers to very quickly expand their supply. Fuel will be trucked in overnight, bread, medicine and other essential goods simply because people see the profit opportunity.

Not because they want to feel good about themselves or because they are trying to appear moral and ethical. But in the end, their actions are the most moral and ethical.

Not only does it send out a price signal to other producers, it provides a very nice reward to those who had the foresight and entrepreneurial skill to provide and supply goods before the emergency strikes. It means that the free market is the best way to prepare for emergencies. Businesses now have a huge profit incentive to rapidly move essential goods to disaster zones before the disaster even strikes. They have a huge profit incentive to analyse and predict natural disasters, and to prepare for them !

And lastly, Option #3 helps avoid stampedes and massive queues.

Obama made fun of it in a recent speech, but it is actually the best thing to "leave it to the free market" and not Washington.