The Economics of Price Gouging

Posted by Ashe | Posted in Free Market Forces, prices | Posted on 07-03-2012

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People tend to complain about high prices, and rightfully so.  If a loaf of bread goes from $2 to $3, all of a sudden you cannot buy those ice cream sandwiches because that money must go towards bread and other necessities instead.  High prices can cause us to have a lower standard of living; this I agree with.

Most people understand that higher prices means less available money to spend on desired goods, but fewer people appreciate high prices as a market signal.  Let’s evaluate high prices for goods after a natural disaster, and use Hurricane Katrina as an example.

When Hurricane Katrina hit New Orleans some people were outraged that businessmen jacked up the prices for their generators.  With the argument that in times of great strife and need people should be willing to sacrifice and assist others, these greedy business men were trying to earn more profit off the backs of these people in dire straits.  While I agree that people in need should be helped; they do not understand the need for temporarily higher prices in these circumstances.

Like all other consumer goods, as demand increases so do prices.  This is a market force/signal that has been understood for a long time, and during a natural disaster there is no exception.  When there is unusually high demand for a particular good, like a generator, prices will rise.  These higher prices tell the Market that there is a shortage of said good.  This also tells businessmen that there is very strong demand, for whatever reason, and will allow them to allocate more of that good (generators) to a certain geographical area.  In this case it is New Orleans.

Without these higher prices, the supply vs demand equation is unbalanced.  If the price of generators did not rise, it would mean that only those who happened to stumble on a generator would get one.  No additional generators would be allocated to New Orleans because the prices would remain the same. This is why you have shortages when price controls are enacted.  If prices aren’t allowed to fluctuate, businessmen will not know where their products are the most desirable or needed.  Would you rather pay 150% of the normal price for a generator during times of great despair, or not have the option to buy a generator at all?  Nobody is forcing you to purchase the generator, and you could have planned ahead and prepared for such a stressful circumstance ahead of time.  If so, you would have been able to buy a generator at its normal price.  Perhaps you could have bought two generators, and put your money where your mouth is and sell it to some needy person at the normal cost.

Higher prices mean that you have less disposable income for other goods/services.  High prices get under our skin, and we smite the businessman for lowering our standard of living. All too often our anger overrides our logic.  Higher prices, in many cases, can be a blessing in disguise.  Without the ability for prices to rise and fall due to supply/demand, we would have empty shelves and an inability to acquire what we desire.  Is it better to go without electricity during the aftermath of a hurricane, or to pay that extra 50% to keep the lights on and food cooked?  The Boy Scout motto of “Be prepared” seems appropriate.

-Ashe

*Recommended Reading:  http://en.wikipedia.org/wiki/Economic_calculation_problem

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