Price Gouging and Hurricane Irene

Over at Future of Capitalism , Ira Stoll suggests that, with Hurricane Irene making landfall, we can expect to hear the usual complaints about, and defenses of, price gouging:

If the usual pattern holds, opportunistic politicians will soon be out denouncing price-gouging connected with Hurricane Irene, while opportunistic free-market economists will soon be out placing op-ed pieces defending prices as the best way to allocate scarce resources and to assure their delivery when and where they are needed . . . .

The New York attorney general, Eric Schneiderman, is . . . getting into the mix, with a letter reminding businesses that state law “forbids those who sell essential consumer goods and services from charging excessive prices during what is clearly an abnormal disruption of the market.”

This strikes me as one of those things where self-regulation works pretty well. If a retailer sets a price too high, he may not sell what he wants to sell, and he may alienate customers. On the other hand, forcing retailers to keep prices low might just assure that scarce supplies sell out quickly to hoarders or resellers.

I yield to no one in defending capitalism (see here and here , for example), and while I appreciate Stoll’s point that a price-gouging retailer will likely suffer reputational harm and destroy goodwill with his customers, I would point out too that there is a good capitalist argument against price gouging.

For, what really happens in price gouging is that extremely rapid changes in market conditions, which the seller did nothing to bring about, create in the seller a temporary and local monopoly. That is, the seller is normally restrained in the prices he can charge by competition from other sellers, but then he suddenly finds this check on his market power removed. Customers who would normally buy elsewhere if the seller charged such high prices suddenly have no alternatives, and thus they pay up.

Now, it may come as a surprise to some people, but consistent capitalists abhor monopolies (except those arising from the monopolist’s superior business acumen—think Google), because monopolies generate significant social costs. Hence, there are good capitalist reasons to prevent the creation of monopolies (again, except for those arising from the monopolist’s superior business acumen), and this is in fact a major purpose of the antitrust laws. Similar capitalist considerations can support laws prohibiting price gouging—or, more accurately, prohibiting the exercise of a local and temporary monopoly power that the possessor thereof did nothing to create.

Still, this isn’t a conclusive argument for laws against price gouging. As a form of monopoly, price gouging generates social costs, but legal prohibitions on price gouging also create costs in the form of enforcement costs, error costs, and so on. Price gouging is thus a genuine problem with at least two possible solutions: either allow price gouging and rely on the seller’s reputational interest to limit the harm, or else outlaw price gouging and maintain a system to enforce the prohibition. Both solutions have costs, and the real issue is which solution entails the lower costs. Unfortunately, the answer is far from clear.