Wednesday, April 4, 2012

A Note on Price Gouging

Of course, there is no economic definition of "price gouging," but let's set that issue aside for a moment and focus on a particular objection in favor of price controls I recently came across.

Suppose that a storm knocks out water in the city and the price for water jumps from $1 to $10 for a single 16 oz. bottle.  If the government imposes price controls that limit the increase to 10% above the 30-day moving average, as many states do, then there will be a shortage. 

So the economist argues that the price spike is good because it reduces use of water and encourages suppliers to bring more in.

The objection runs like this, if you are a poor guy, you can't afford the $10 price and so you go without.  Alternatively, if we have to stand in line for rationed water, he has a chance to get some water.

This scenario is a false dichotomy.  Regardless of the method of distribution (by price, by 1st come/1st served, etc.), some people will be without water.  The reason is that a storm has knocked out the water supply. 

The correct question to ask is, "Which system gets water to the damaged area faster, so that the time is minimized for those who are without water?"

The correct answer is the price system.  High prices send a signal, to all, that water is needed in the area and rewards those who are there first with high revenues.  As the water comes "flooding" in (yes, a pun), the price falls and then even the "poor guy" will be able to get water.

Disasters are horrible situations to live through.  I remember the eye of a hurricane passing overhead.  It was an interesting experience.  The point is which system puts into place a system of incentives that gets the most relief to the most people in the shortest period of time.  And the best answer we have is the open and free market.


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