The Short-Sightedness of Anti-Price-Gouging Legislation

Columnist Michael Hiltzik wrote a piece in the LA Times the other day calling economists’ opposition price-gouging legislation wrong “both morally and economically.”  By pure coincidence, I addressed the “moral” argument yesterday on this blog.  Allow me now to respond to a very large economic error he makes.

Hiltzik writes:

Another factor commonly overlooked by defenders of price gouging is that natural disasters tend to be (1) short-term and (2) not amenable to rapid response by market forces. If there’s no physical way to get a new supply of bottled water into some part of Houston, then allowing unrestrained price increases won’t produce a larger supply. Retailers lucky enough to have a few cases in the back room when the crisis hits, however, will reap a windfall. But who does that help, except the lucky retailers?

Strictly speaking, he is correct that natural disasters tend to be short-term, at least the disaster itself.  It may also mean that it is not amenable to a “rapid response by market forces.”  But that doesn’t necessarily mean that anti-price-gouging legislation is the way to go.

Take a look at the following diagram:

IMG_20170830_125948

Source: Price Theory and Applications, 7th Ed., by Jack Hirshleifer, Amihai Glazer, and David Hirshleifer, page 214.

This is just your standard supply and demand chart with price on the vertical axis and quantity on the horizontal.  Let’s assume that curves IS (Immediate Run Supply Curve) and D (Demand) are immediately before Harvey hits Houston.  Immediately after, demand shifts to the dashed D’ curve.  IS doesn’t immediately change because there are now frictions (ie flooded roads) preventing new supplies coming in.  The price level now rises to PI (the intersection where the D’ curve intersects IS).  This increase in price is what people call “price-gouging.”  The “lucky few” retailers who have the inventory on hand may enjoy a brief windfall.  This is where Mr. Hiltzik’s analysis ends.  What he doesn’t consider is what happens as we move away from the immediate period and into the longer run (the days that occur after the disaster).  Higher prices induce more supply to the region, especially as entrepreneurs discover ways to overcome the physical barriers preventing supplies from arriving.  And, as the Second Law of Supply says, the longer prices stay relatively high, the more elastic the supply curve becomes.  We see the development of the LS (Long-run Supply curve) in the diagram above.  If there is no interference in the market, we now see increased supply in the market (represented by the delta-S section in the above diagram).

However, Mr. Hiltzik demands a price ceiling to be imposed to prevent this higher price level.  On the above diagram, that is represented by the original price level, Po.  In the immediate run, there is no deadweight loss to the community stemming from the price ceiling (eagle-eyed readers will notice this is identical to the question from my microeconomics comprehensive exam from three weeks ago).  There is no deadweight loss, but there is a shortage, represented by area H on the above diagram.  However, what is important to note is that with the price ceiling enforced, even as the supply curve becomes more elastic and more supplies can make it into the devastated area the shortage does not disappear!  No additional supplies make it into the market despite the need!  The quantity the market supplies never shifts off of Qo.  Nota bene: This means that, so long as the demand for goods and services are higher than the pre-disaster level (ie, so long as disaster conditions persist), there is a persistent shortage of needed goods in the market! This stands in stark contrast to the increase in supply created when prices are allowed to adjust.

In short, Mr. Hiltzik’s analysis is too short-sighted.  He looks at just the immediate run (which is dire) but fails to account for anything beyond that (including the very next day).  And we are already beyond the IS curve for Harvey; the supply curve is becoming more and more elastic every day.  And it is becoming that way because of the price signal.  Even in the immediate run, anti-price-gouging legislation has major negative consequences.

I’d also like to add that the situation described above is probably a bit optimistic.  In all likelihood, following Harvey, we saw both an increase in demand (D’) and a decrease in supply (a shift from IS to an IS’ curve somewhere to the left of the IS curve).  So the shortage, H, caused by the price ceiling would likely be larger than depicted here.

12 thoughts on “The Short-Sightedness of Anti-Price-Gouging Legislation

  1. Jon, I wouldn’t worry a lot about resources spent on enforcement, The fact is most rules.laws are dependent and planned on self compliance of the majority of people who do follow rules. If the rule stops unwanted behavior of the targeted majority, merely a few token and well-publicized cases of violators is all that is needed (and those can be quietly dropped after the publicity dies down).

    A good negotiator can usually get something quietly dropped or greatly reduced if they are willing to let the other side have their cake and time in the light (that is, I won’t fight you now, but off-the-record, let’s drop this in 180 days, OK?)

    How about some research on what actually becomes of these gouging law violations? I’m guessing not much.

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    • Walt

      Why should those cases be “quietly dropped”? If someone breaks the law shouldn’t they be punished?

      Besides some of those fines are pretty hefty. That’s good revenue for the state or city.

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      • Ron, a lot of rules/laws are symbolic and/or for popularity and are dependent mostly on voluntary compliance. Did you notice the violations are addressed on a written complaint with evidence-provided basis? How much do you suppose police would spend on enforcing speed limits if they only investigated and ticketed from other drivers’ written complaints that provide evidence for the ticket?

        I’m still guessing most violations are not charged and the ones that are not much comes of them if you look a year or so later. I tried, but did not find, the final outcome in the Shepperdson case. I’m only addressing Jon’s resource usage complaint here and not the law itself.

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      • “If someone breaks the law shouldn’t they be punished?”
        It takes scarce resources to continue a fight to possibly eventually win. If publicly spanking a few people gets the voluntary rate to an acceptable percentage, that is all that is necessary. A rule/law/policy maker’s nightmare is that the voluntary compliance rate is zero.

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        • Nothing promotes disrespect for the law like non-enforcement.

          It takes scarce resources to continue a fight to possibly eventually win.

          Taxpayer money is one resource that is seldom scarce. There seems to be an endless supply of it. It’s likely that any decision on whether or not to pursue a charge is at the whim of the prosecutor, not due to any concern for resources.

          What is an acceptable rate of law breaking? And whatever happened to equal treatment under the law?

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          • Ron, few things can be 100% and affordable (not even “O” rings for the Space Shuttle). If I can get 95% voluntary compliance with a “Do Not Touch”: sign on a delicate object in museum, and that is sufficient to protect that object, I am not going to pay for 2 armed guards 24/7 to guard that object.

            Again, laws. rules, regulations, policies . . . are usually dependent on a very high voluntary compliance rate (some are never even intended to be enforced). I doubt the actual enforcement cost of the anti-gouging laws in an average state would even be a rounding error in the budget. Are you going to buy 19 generators and try the laws out during the next hurricane in Mississippi after Shepperdson?

            How much would you budget to have a 100% compliance rate for speed limits in a city if you were a mayor of that city? Would any money be left over for anything else if you tried?

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          • Ron,

            >—-“Nothing promotes disrespect for the law like non-enforcement.”

            It would be easier to take you seriously on this if you didn’t want the law enforced only by vigilantes and private security for those who could afford it.

            >—“Taxpayer money is one resource that is seldom scarce. There seems to be an endless supply of it.”

            It would be easier to take you seriously on this if you didn’t think that government debt was such a big problem. If it’s so easy to raise tax revenue then why is the government taking on such an alarming amount of debt? You can’t have it both ways here on the ease of collecting taxes.

            >—” And whatever happened to equal treatment under the law?”

            It would be easier to take you seriously on this if you didn’t support a system where justice was only available to those who could pay for it themselves or through private charity.

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          • Hi Greg

            Sorry I didn’t see your comment earlier.

            I didn’t intend that you take me seriously.

            BTW I think it’s government *spending* that’s a problem. Taxes and debt are just two ways to spend taxpayers’ money. And of course inflation is another.

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