In a segment on the economics of price gouging on NPR Marketplace last Friday [it starts at about the 11:40 point], my former University of Rochester colleague Richard Thaler points out that merchants who price gouge create ill will among their regular customers that will come back to bite them later. He’s right. In response, Don Boudreaux lays out clearly both the fact that Thaler is right and, more important, the fact that this does not undercut the case for allowing price gouging. Don writes:

Yet surely no one is more aware of this downside of “price gouging” – and more interested in avoiding it – than are merchants themselves. Therefore, if after a natural disaster we nevertheless witness significant price hikes, we must ask why the price-hiking merchants are knowingly risking their reputations with consumers. The obvious answer is that the natural disaster caused supplies of goods to fall so extremely that it pays merchants to raise prices even though doing so imperils these merchants’ good reputations.

There’s another point to make too. We economists point out, as I did here, that the higher prices during emergencies attract resources–water, plywood, etc.–from other parts of the country. Think about who those people are who are supplying the resources. The obvious point is that they probably wouldn’t do it if they were not allowed to charge higher-than-normal prices. The more-subtle point is that they don’t have to worry about lost good will from future customers because many of them are engaged in one-time transactions. The guy who thinks to buy a lot of cases of water in advance and then sell them to others may not even be in the water business. He’s simply trying to make a buck by doing something that buyers show by their actions is very valuable.

As I pointed out in my interview, by allowing price gouging, we get, to some extent, the best of both worlds. We get the traditional merchants like Wal-Mart, who worry about reputation, stocking certain supplies in advance and not raising prices. We also get the fringe, one-time suppliers, bringing in more supplies in response to the higher prices they can charge.

I found this quote from Thaler, at the 15:09 point, economically illiterate:

A time of crisis is a time for all of us to pitch in; it’s not a time for all of us to grab.

Remember that he said this in the context of opposition to price gouging. But what price gouging does, as Don Boudreaux points out, is cause people far from the crisis spot to pitch in by temporarily foregoing buying the water, plywood, etc. that, due to price gouging, are priced higher even outside the directly affected area.

P.S. If you’re inclined to dis NPR Marketplace, then listen to the whole thing. It goes only about 4 minutes. They do a nice job, calling on two economists and one philosopher, of laying out the beneficial economics of price-gouging before going to Thaler to give an alternate, if badly thought out, counterpoint. My one criticism is that the host, Kai Ryssdal, leads by saying that “the free market is cold-blooded, heartless.” He never says why, assuming, as he probably knows he can, that most of his listeners will agree with him.