Price Gouging Is Bad

 J L Austin

J L Austin once wrote a book How To Do Things With Words. One of the most important - or at least most analyzed - branch of words is "prices" - those signals that firms use to advertise their willingness to part with wares. Prices reflect many things: cost of production*, noise, willingness to purchase and the spatial, temporal & political relations between the seller(s) and the purchaser(s).

Milton Friedman, Theodore Schultz & George Stigler

There's an easy case. In the Heaven of "perfect competition", the price of a good balances two aspects: 1) the aggregate choices of all consumers and potential consumers is indifferent between purchasing and not purchasing an extra bit of that good and 2) the aggregate of all producers must be indifferent between manufacturing and not manufacturing an extra bit of good.

In this topsy-turvy Never-Never Land, "price gouging" - sudden price rise immediately after a natural disaster - is Actually Good. Technocratically and morally good. A rising price reflects a greater need on the part of the consumer, which will be met by profit hungry producers**.

Despite what Richard Posner tells you, we do not live in this place.

Harold Hotelling

It is simply not the case that the rise in price necessarily reflects a change in demand. The change in price can reflect a rise in the monopoly power of firms - a flood creates huge transaction costs. Recall the famous Hotelling Spatial Model of competition - one of the earliest completely specified monopolistic competition models. What happens when the transaction costs increase? We already know this. Transparency goes down, consumer surplus is consumed ... and profits go up. Exactly what is observed.

Ed Chamberlin

Neither is it the case that profit hungry firms can necessarily enter the market to meet demand. In order for a firm to enter a market, the long term expected profit to an entrepreneur must be non-negative. They must be able to overcome, for instance, fixed costs and compete with established firms with increasing returns. A flood creates higher fixed costs for entry - depressing the number of firms that can enter. A bit of price gouging is probably not enough to overcome this effect.

King Vidor

Okay, but let's say you really want to believe in this "perfect competition" story. Maybe it isn't right in detail but you think it gives you the right ... laws of motion. Maybe not always but on average, in a broad sense of the term "average". This was Ol' Frank Knight's opinion on the nature of perfect competition predictions, so you're in good company.

Yes, you admit that most people who hold this position are just contrarians who haven't thought beyond the textbook case. But you're not. You genuinely believe that local multipliers are generally strong enough that price increases - perhaps alongside government spending - generally returned devastated regions to the "status quo ante clades". This is a defensible position, econometrically. At least with small disasters, it seems to be true: every rainy day increases transaction costs - but they don't all destroy the city.

Then how do you take into account that this isn't true in general? Do you think that the unregulated markets of the late 19th century just didn't gouge enough?

I'll make my long story short: automatic disaster relief > price gouging. It's true that there should be changes in economic fundamentals: rain taxes, infrastructure investment, enforcing flood insurance laws, fixing zoning so that flood absorbing lands aren't eaten by sprawl (this is probably irreversible at this point - urban sprawl is one of worst ecological disasters in history but nobody does anything about it...) - but locally, around the disaster the important thing is to get spending back and let the multiplier work itself out. There's no a priori reason to think price gouging will help and not hurt.


Prices are signals, words. Don't think those words can't be "Screw you!".

*"cost" should be understood in a very wide sense.

**It has been well established since Walras that "perfect competition" means constant returns, so small firms can always come up to meet demand in that mystic realm.