Category: Economics

The Moral Ambiguity of Price Gouging

Like a TV series, I feel obligated to begin this post with a synopsis of my last post since this is a three-parter.  My overall objective is to consider two intriguing current issues – price gouging (this post) and net neutrality (next post) utilizing an Arthut Okun-influenced economic framework for considering important public policy issues (previous post).

So here goes.  “Previously on Garygrams:”

A capitalist system uses market-clearing prices, and the ability and willingness of buyers to pay those prices, as the primary criteria for rationing scarce goods and services.  . . .  .  While the allocative result is efficient and socially beneficial, the morality of using what Okun calls ‘dollar votes’ to determine what is produced and who gets what is left unanswered.

But what if some ‘event’ significantly and quickly changes the openness of markets and the demand urgency of some individual buyers?  That’s essentially what happened most recently when Hurricane Irma set its sights on Florida.  Numerous reports surfaced of price gouging in the form of $20-per-gallon gasoline, $12-per-bottle water and $3,200 for a Delta ticket out of Florida, followed by predictable expressions of moral outrage and calls for price controls from both defenders and critics of free markets.

As is often the case, however, the reality is more ambiguous.  It turns out, for example, that the alleged $3,200 airline ticket price wasn’t actually hurricane-related price gouging at all.  Airlines have been charging similar ‘peak-demand’ fares to last-minute buyers for years by basically segregating such buyers from the remainder of the market.  So whether for weather, family, business or any other compelling circumstance, some affected buyers are suddenly willing to pay almost anything to buy a seat on the next plane.  To a much lesser extent, the same is true for Uber’s surge pricing, Amazon’s data-driven repricing scheme, drastically elevated hotel rates during major events or even in-season vs. off-season pricing at many vacation spots.  In all these instances sellers are able to segregate buyer groups based on demand (or elasticity of demand) changes and thereby charge more buyers something close to their reservation price.

But what if any are the moral implications of these pricing policies?  To the general public these practices often seem outrageous, but to many economists they are acceptable and even beneficial.  To them, recall that market-clearing prices (mcp) act as the primary rationing device in a market economy.  This is no less true when something suddenly becomes much more scarce (or in higher or more urgent demand) due to a market-shocking event.  And it really makes no difference whether that event is a weather emergency or heavy hotel demand due to the Super Bowl.  Remember, the market allocation and distribution processes are perceived as amoral.

Moreover, according to free market economists, adopting price controls to eliminate or lessen gouging will actually worsen the problem by removing the incentive to conserve.  Consider for example a hotel that normally charges $75 per room, but which raises the price to $200 during a weather emergency.  A large family that might have rented two rooms at $75 will likely choose to put everyone in one room at $200, and a family whose home was damaged but livable would be more likely to stay at home with a hotel cost of $200 as opposed to $75.  In either case the higher price encourages economizing and actually frees up rooms as compared to the low price.

And if for example the price is capped at $75 by law, what’s to prevent a black market from arising where an unscrupulous customer purchases a block of rooms at $75 and then resells all but the one he uses at $200?  More generally, prices capped below the mcp reduce supply.  A Georgia supplier of bottled water would have a tremendous incentive to quickly get trucks moving to hurricane-ravaged Florida if the price rose to $12 per bottle, but little incentive if the price was capped by law at $1.

So are these economists right and bleeding heart price-cappers misguided?  Yes and no.  The economists are right that all sorts of ‘events,’ from the popularity of the Broadway musical Hamilton to the threat of a devastating hurricane, increase demand and demand urgency, which inevitably drives up the mcp.  They are also right that capping prices below the mcp creates unintended consequences such as black markets and requires rationing the increasingly scarce commodities and services in some other manner (hello queues).

But lets think just a bit more about the magic of rationing scarce stuff through prices alone.  What determines who ultimately gets the stuff is not the mcp, but rather the ability and willingness to pay the mcp, i.e., what Okun calls dollar votes.  That may be morally acceptable as well as economically efficient when we’re talking about doubling the Uber rate in Times Square on New Year’s Eve.  Some folks may not be willing or even able to pay the higher rate, but then again their personal well-being is not dependent on an expedient trip home.  But when markets for essential goods and services are disrupted by natural disasters or quasi-monopolistic providers (big pharm, I’m looking at you), survival may become paramount.  Under these circumstances allowing dollar votes alone to determine who gets scarce life-saving products and services is morally unacceptable.

Therefore using Okun’s conceptual framework, I would conclude that the basic availability of essential life-saving goods and services should be guaranteed to all under the domain of rights, rather than being rationed by ability to pay in the domain of dollars.  Of course what this implies as an optimal public policy is much more complicated.  But one thing is certain – price controls do not constitute a departure from the domain of dollars, but rather a simplistically ineffective subterfuge for remaining there.  So simply prohibiting price gouging by law is not the answer.  Removal of essential-to-life goods and services from any marketplace is required, with their provision guaranteed by government just as is, for example, K-12 education.  Okun’s bottom line is that “the market needs a place, and the market needs to be kept in its place.”  Uber and Marriott rates fall within that place, but disaster survivability clearly does not.

 

The Amorality of the Marketplace

As November conjurs up sentiments of food, family and Thanksgiving for many, I’ve found my admittedly perverted mind revisiting the late great economist Arthur Okun.  Why?  Because his brilliant presentation of the operations, strengths and weaknesses of the competitive marketplace in Equality and Efficiency: The Big Tradeoff (1975) continues to provide valuable insights for thinking about contemporary issues.  Sharing some of these insights first requires outlining some fundamental economic principles within Okun’s basic context.  That is the purpose of this post.  But please be assured that enlightenment will follow for those resilient readers who survive the Econ lesson, as my two followup posts will apply these economic principles to two intriguing and seemingly unrelated current issues:  price gouging and net neutrality.

First the economics, in brief.  Assuming sufficient competition and information, self-interested buyers (demanders) and sellers (suppliers) of let’s say widgets ‘come together’ in a marketplace to exchange buyer money for seller widgets.  In this familiar process a ‘market-clearing price’ for the widgets (let’s call it ‘mcp’) is established that equates supply and demand.  Textbook Econ 101.

Somewhat less recognized are various important corollaries of this process.  They include:

  • Some sellers of widgets choose to restrict production because the mcp is not high enough to make additional production profitable.
  • Some buyers cannot afford to buy many if any widgets at the mcp.
  • Other buyers would actually be willing to pay more than the mcp but don’t have to because there’s only one price.
  • Sellers would prefer to charge each buyer the maximum price they would be willing and able to pay (economists call this price their ‘reservation price’ and this process ‘price discrimination’), but they can’t because with competition and free information all buyers will seek out the mcp.
  • Since widgets and the resources used to produce them are inevitably scarce, the mcp serves as an efficient rationing device to allocate widgets to those most able and willing to pay for them.
  • While individual buyers and sellers are motivated solely by their own self-interest, competition ensures that society benefits from this allocative efficiency (essentially Adam Smith’s ‘invisible hand’).
  • On the other hand, the unequal distributional impacts on individual widget buyers and sellers are treated as essentially irrelevant.  Some sellers can sell many widgets profitably at the mcp, while others cannot.  Some buyers can afford to buy many widgets at the mcp, while others can buy none.  In this process no value judgments are made about the fairness of the results.  The system is ‘value-free,’ and therefore amoral.

To generalize, the resources necessary to provide widgets and all other products/services are inevitably scarce, and given this scarcity every society must have some rationing mechanisms/criteria for choosing what, how and for whom it produces.  A market-oriented capitalistic society blindly uses prices (mcp’s), and the ability and willingness to pay those prices, as its primary rationing criterion.  The results are efficient and unequal (see Okun’s title), as well as morally neutral.

Note also that in theory a society could choose many other rationing criteria instead of prices.  For example a central authority could determine that 100 widgets will be produced, and then distributed free on a first come-first served basis.  Here the queue is the rationing device.  Arguably more equal or fair, but less efficient (see Okun’s title once again).

Of course, in the real world the rationing process is often more complex and hybrid in nature.  Societies identify some ‘public goods or services’ that must be provided free or at a subsidized price, e.g., public parks or K-12 education.  Another variant is the so-called ‘public utility’ such as electricity or water provision, whose extensive infrastructure requirements necessitate treatment as a regulated monopoly.

In addition, because market information is not perfect many businesses generate a product or service and then choose a price, mcp or not, that covers its costs including a reasonable profit.  Such businesses typically do not try to continuously adjust their prices in search of the mcp.  Rather, they also employ queueing as a rationing device while adjusting production if the product sells out.  For example, Apple recently introduced its new iPhone X at a price of $999, a price that is unlikely to change anytime soon.  Is this the mcp for the iPhone X?  Probably not, but if the demand exceeds the supply lines will form at Apple Stores and some buyers will need to wait until production increases.

But the fundamental principles remain.  A capitalist system uses market-clearing prices, and the ability and willingness of buyers to pay those prices, as the primary criteria for rationing scarce goods and services.  So long as markets are sufficiently open and competitive, scarce resources are efficiently allocated among competing uses.  In fact, individual self-interest drives the system to this result.  While the allocative result is efficient and socially beneficial, the morality of using what Okun calls ‘dollar votes’ to determine what is produced and who gets what is left unanswered.

If you’ve made it this far without dozing off, congratulations!  The basic Econ lesson is over.  As noted at the outset, these principles can provide insight into many current issues, but I have chosen two.  My first followup post within the next couple of days will consider the efficiency and equity of price gouging (Teaser: Should sellers be able to drastically increase the price of basic consumables during a crisis?).  Stay tuned.