"Price Gouging" Laws: Ten Research Areas in the Economics of Unintended Consequences

By Michael Giberson -- December 11, 2012

For most economists, the workings of “price gouging” laws are simple and predictable. Binding price caps in emergencies create shortages on the most urgently needed goods and services during emergencies.

The recommended policy reform is simple, too: stop harming citizens when they can least afford it!

It would seem to be an open-and-shut case, a slam dunk for economics to inform the electorate and thus policymakers to avoid such folly. Remember the gasoline lines and natural gas shortages of the 1970s? Perhaps no simple event has convinced mainstream economists that price controls have bad consequences despite intention.

Defenders of economic liberty have an even easier argument: merchants ought to be free to ask what ever price they like for the goods and services they offer. Price gouging laws unjustly limit that freedom and government ought not to do that.

Yet, some 34 states and the District of Columbia have laws that impose price caps on urgently needed goods and services during emergencies. The easy arguments of free-market economists are not winning policy debates.

One response is to make it easier for the non-specialist to understand why price gouging laws cause more harm than good, as with Matt Zwolinski’s short video on price gouging for LearnLiberty.org. My own price gouging essay in Regulation magazine might serve a similar purpose for the non-specialist policymaker audience.

A complementary line of work digs deeper into the economics of price gouging in an effort to trace out the consequences of the laws. Defenders of price gouging prohibitions are comforted by their good intentions and a vague sense that somehow emergencies would be worse if prices were freer to adjust. Careful empirical and theoretical work on the consequences of price gouging laws can help undermine this false comfort.

In that spirit, here are ten researchable price gouging topics for economists.

1. Economics of odd-even rationing

In a policy move seemingly straight out of the 1970s, Gov. Chris Christie imposed odd-even rationing on gasoline purchasers in twelve northern New Jersey counties. The move was widely seen as helpful by the public and soon copied in New York.

There has been some economic analysis of odd-even rationing, as the Wall Street Journal’s Carl Bialik noted, mostly straight out of the 1970s as well, and mostly saying it won’t help. A good study would examine New Jersey’s most recent brief experience with odd-even rationing in order to show whether or not it helped consumers.

2. Shortages and the hoarding impulse

Often when gasoline supplies are tight, consumers feel an urge to keep their gas tanks fuller than usual. The result: more consumers refueling more often (‘tank topping’), exacerbating the shortage and adding to the gas lines. As economist Eric Crampton explained, it is “a terrible equilibrium where everyone’s rational response to the below-clearing price was to hoard, because there was real risk that the stations would run out of fuel.

And there was real risk of running out of fuel because of the hoarding.” It is a frequent issue. In addition to New Jersey and New York post-Sandy this year, several Southeastern states experienced a hoarding equilibrium after Hurricane Ike in 2008 reduced gasoline supplies for a few weeks.

3. Distributional effects of price gouging prohibitions

A common argument against allowing prices to rise after emergencies is that only the wealthy would be able to buy goods and services at disaster-spiked prices. One response would be to question the suggestion that prices would spike to unreasonable levels – Maryland and Delaware don’t have price gouging prohibitions while all neighboring states do, so do we see sky-high prices during emergencies in these two states?

But another response is to dig directly into the question of the impact of disasters on the poor and consideration of whether capping prices and impeding the normal supply and demand responses to high prices aids or hurts the poor. The easy economics says price caps hurt consumers, so it should be easy to come up with evidence that poor consumers are worse off with the price caps.

4. Non-price rationing techniques: queuing and beyond

When price adjustments are blocked, other mechanisms are employed to determine who gets what. Often the rule is form a line and first-come, first-served at the capped price. Sometimes merchants supplement first-come, first-served with quantity limits.

Defenders of price gouging laws sometimes suggest that poor people have more time than money relative to wealthy people, so queuing can shift some goods in the direction of the poor. The obvious question is whether this is true in practice: are these methods are better at ensuring goods in short supply reach the people most in need?

Related questions concern whether there are non-price rationing mechanisms beyond queuing and quantity limits – odd-even rationing? – that would do a better job than letting prices adjust freely.

5. Short-run elasticity of supply after disasters

Another very basic, not-yet-well-answered question concerns the short-run elasticity of supply of useful goods and services. Defenders of price gouging limits often believe supply will be very inelastic, so policy can ignore the potential supply response to higher prices. Critics of price gouging limits often suggest the potential supply response is a reason to think higher prices are moral in addition to efficient: more goods reach people in desperate need.

A problem here is that each case will be different, so no answer is final. However, if detailed case studies show that the price elasticity of supply is reasonably high, then concerns over price spikes may be eased. A ten-dollar price spike lasting a day or two is likely preferable to a week or two of two-hour long gasoline lines at capped prices. Here is one related research effort.

6. Short-run elasticity of demand after disasters

A similar issue arises on the demand side: just how much will consumers back off quantity demanded if prices are allowed to rise. Advocates of price gouging laws sometimes argue as if the quantity demanded is fixed – as if so many families displaced means a fixed number of hotel rooms demanded – so all a price increase does is transfer wealth from disaster-struck consumers to greedy merchants.

Opponents of price gouging laws insist that demand remains elastic even under emergency conditions – consumers can find substitutes, make do with their goods, and find other ways to reduce their immediate use – and that such demand-side adjustment helps goods reach consumers with the greatest needs. A researcher could detail how such demand-side adjustments work in practice to conserve useful goods. Here is one example: higher prices mean rooms more likely available to travelers with longer distances to drive during snow storms.

7. Organizational form and price gouging enforcement

Large scale, vertically integrated businesses with advanced logistical capabilities will find it easier to recover after disasters. Businesses working over large geographical area are inherently better diversified against a disaster. Businesses with nationwide reputations have more at risk from poor responses and more to gain from strong responses.

Small mom-and-pop stores typically have fewer outside resources to shift into disaster struck areas and may find their own capability to respond damaged by storms. The clear implication is that price gouging laws likely burden small businesses more than large businesses.

A casual review of price gouging enforcement actions suggests it is true – just look at which gasoline stations are being charged by New York and New Jersey in the aftermath of Sandy. (Though sometimes larger companies like Marathon Oil find themselves targeted.) Related is work on price gouging laws and supply chain dynamics.

8. Economics of consumer price complaints

Most price gouging enforcement actions begin as phone calls to state-maintained consumer complaint hotlines. Attorneys General could subscribe to gasoline price data services, but such systematic searches for violations hardly ever occur. Consumer complaints are the mainstay.

A problem here, however, is that it puts a key step in the law enforcement process in the hands of consumers. (Remember, a premise of the price gouging policy is that these desperate consumers can’t be trusted to make reasonable decisions on prices for themselves and need state protection, so it seems a little odd that policymakers are so willing to trust that consumers will play this law enforcement role well.)

One clear problem is that consumer complaints may be biased by things other than the mere facts about prices, perhaps to the detriment of minority merchants. Question: Are consumers’ price gouging complaints biased?

9. Studies of price gouging enforcement

The price gouging enforcer’s response to the previous issue might be to admit consumer complaints may be biased, but claim agency review of complaints erases bias. Follow-up question: Does it?

Another question concerns the relationship between price gouging enforcement and political ambition. Are anti-price gouging pronouncements by politicians just a cheap way for them to “look busy” in the face of a disaster? In the Marathon Oil price gouging case mentioned above, the company couldn’t help but notice that twice it was charged with price gouging very publicly in the few weeks immediately before a primary election in which the attorney general was on the ballot (2007 and 2011).

As price gouging laws are often vague – prohibiting “unconscionable” or “unreasonably excessive” price increases without explaining just what that mean – another role for empirical study of price gouging enforcement would be to determine whether such vague standards are enforced consistently across cases. Merchants often complain they can’t tell what, precisely, such laws prohibit, and as a result they must operate conservatively or risk accidentally violating the law.

10. Efficiency defenses of price gouging laws

It is difficult to find many carefully reasoned arguments in favor of price gouging laws. Jeremy Snyder’s article, “What’s the Matter with Price Gouging?” in the Business Ethics Quarterly may be the best available. But Snyder mostly admits the standard economics efficiency case against price gouging prohibitions, then argues that price gouging is nonetheless wrong on moral grounds. (For more on ethics, see Zwolinski’s earlier article and the resulting dialog with Snyder.) Michael Sandel suggests a community-spirit based defense of price gouging policies in his book Justice (though I don’t think it stands up to analysis: see blog posts here, here, and briefly here).

Are there any good efficiency-based defenses of the laws? Jeff Ely’s blog post on price gouging, if you follow the links, suggests a possible theoretical approach, but it takes the questionable premise that supply is fixed in the short run and only consumer surplus matters. Geoffrey Rapp offers an economic defense of price gouging laws in the Kentucky Law Journal, but it fails to satisfy the interested reader (see also David Skarbek’s response in the Public Contract Law Journal). In a book chapter, Zwolinski considers a market failure case in favor of price gouging restrictions and finds it lacking. Are there other thoughtful attempts to argue that price gouging policies make us better off?

Too simple to study?

Professional economists may think price gouging laws and their effects are too simple to be worth studying carefully. Sure, price caps are real, and binding price caps lead to shortages and non-binding price caps are irrelevant. Principles of economics stuff, what else is there to study? Sometimes it is argued that “price gouging doesn’t exist” and so there is nothing there to actually study.

I argue otherwise.

Yet if the case against price gouging restrictions was so blindingly obvious, why are more and more states enacting such laws? Thomas Sowell invokes Joseph Schumpeter on this point, saying “it is a mistake to dismiss some ideas as too silly to discuss, because that only allows fallacies to flourish.”

Simple economic literacy will help, and straightforward attempts to expose the problems with the laws will help as well. But to root out price gouging policies that are harming folks in disaster-struck regions we need to get beyond the simple stuff and dig into the nuts and bolts of price gouging policy. These ten topics offer many ways to get started.

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Michael Giberson, assistant professor of practice in the Energy Commerce program at Texas Tech University, blogs frequently on price gouging law and policy at Knowledge Problem.