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September 15, 2008
Thank God for Price
This column deals with
the theory behind “price gouging.”
Tomorrow’s column will apply the
theory to recent and ongoing situations in hurricane-affected areas.
wake of the recent hurricanes that have hit the south, the recurrent
issue of “price gouging” has inevitably arisen as officials in the
affected areas go on a hunt for any vendor who dares to raise prices.
Little do they know, however, that they are doing the people they serve
a major disservice.
Let’s take the gas stations as an example. No one knows where
their prices should be at any one point except for the gas stations
themselves. What they generally should do, and what they actually do (as
long as there is no government interference), is sell at a price
But then an emergency happens, like Hurricane Katrina.
Hundreds of thousands of people are cut off from the world for a week.
Transportation into Louisiana is down, and supply lines for local
businesses are non-existent. The gas stations in Louisiana don’t have a
way to re-supply, and they have to work with only what they have in
stock (as do grocery stores, etc.).
Because there is a shortage of gas in the area, a gas station
owner will logically raise the price of his gas from, say, $3 a gallon,
because he will not be getting re-supplied anytime soon, and demand
hasn’t dropped to compensate for this lack of gas. So by raising the
price, he is making people bid for the gas in a way. Let’s say that
judging from the demand he is getting, from the prices of his
competition, and from other economic factors, he decides that at $8 a
gallon he will make the most profit. In other words, at under $8 he will
sell everything before he gets re-supplied, and at over $8 he won’t be
able to sell enough to make as much profit as he would at $8.
Now when he (and his competition) does this, people become
indignant. “Look at this guy! He was selling gas for $3 a gallon
yesterday and now he’s more than doubled it! He’s ripping us off!” Then
the media starts reporting that gas station owners are engaged in “price
and the politicians make speeches about how we shouldn’t let the evil
gas station owners profit off of hard-working people. They pass a law
that says if you sell gas at more than (a highly arbitrary) $3 a gallon,
you are going to be prosecuted.
At $3, people will buy at least as much gas as they were
buying before (in fact, they will probably buy much more, because they
know that the gas stations will run out). There are long lines at the
pump, and the lucky ones who happened to get there first buy as much gas
as they can. The rest are left without any gas whatsoever.
It could very well be that those who did get the gas were
teenagers who don’t really need to drive their cars, and who will burn
the gas by just driving around town. And it could very well be that
those who did not get the gas needed it the most, because their business
depends entirely on it, or they have to drive to Grandma’s, who is alone
in the aftermath of the storm.
So it is true that lowering gas prices to $3 sounds
good, in the sense that people might not be angry about being “ripped
off.” But in reality, they are. While a lucky few get the gas, the rest
have no hope of driving regardless of how urgently they need to do so.
So how do we resolve this? How do we know who truly needs the
gas and who does not? No person or government agency knows, nor will
they ever know. Instead, the best way to discriminate in favor of those
who need the most gas and against those who do not is, in fact, to
increase the price. A bunch of teenagers driving around their high
school would not be willing to pay $8 for the gas, but someone who needs
the gas for an emergency, such as getting to sick grandma, will pay $8.
And so you know, if you really need gas for an emergency or
an important trip, there will always be gas for you there, even if it is
expensive. At $3 a gallon, however, the gas is long gone, and wasted.
Indeed, expensive gas is better than no gas.
Of course this does not only apply to gas. Take bottled water
in a Katrina-like situation. The price goes up from $1 to $7 a bottle,
people get angry, and the politicians force the price to remain at $1.
Again, it is going to be hogged. Whoever gets to the grocery store
first, even if they had just received their delivery of water dispenser
containers that will last them three months, will still buy all the
cheap water and put it to whatever use – brushing their teeth, washing
their dogs, watering their plants. But those who do not have water at
home and urgently need to drink, and who arrive late, remain thirsty
because there is no water left. The government never knows who needs the
water most. The best way to determine need is through the price system.
Allowing prices to discriminate in favor of the truly needy
is such an effective mechanism that no government should ever interfere
with it. One fine economist even labels the process “economic triage.”
Indeed, following a bomb explosion at a restaurant, the
medics are clearly expected to care for those who lost two limbs prior
to those who scratched their elbows. But having the government prevent
price-driven discrimination between those who need products the most and
those who do not need them much is like having the government force
medics to give everyone equal attention at a health disaster scene.
© 2008 North Star
Writers Group. May not be republished without permission.
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