Price Signals, Price Gouging, and Philanthropy
By Peter Calcagno
In the wake of the (COVID-19) pandemic news outlets and politicians alike are discouraging everyone from price-gouging and hoarding. The question is why? We are told that to raise the prices during a crisis such as a natural disaster or a pandemic is cruel and unethical. However, as any good principles of economics student can tell you, price gouging laws only create price ceilings and shortages of goods. No one is directly calling for the capping of prices on goods during these times of crisis, but price gouging laws are effectively the same. Producers are afraid of raising prices for fear they may be reported as price gouging, and in many states, the burden of proof is on the producer to demonstrate they did not engage in price gouging.
The issue at hand is an old one in economics that people keep failing to learn. Prices are signals that contain information and incentives and help to ration goods. F.A. Hayek demonstrated that we do not have to know why prices are rising to understand how to behave. As consumers, we economize on goods, and producers understand that there is a greater demand for the product and should offer more to the market. What price gouging laws cannot do is change the scarcity of resources as Michael Munger explained to us years ago after Hurricane Fran. Instead, we have to find new ways to allocate scarce resources like waiting in line for first come, first served, or worse discriminatory practices. Yes, this sometimes forces us to make hard choices as to whether we should forgo the beer for toilet paper (or maybe it’s the other way around).
Preventing prices from rising only creates confusion among producers and consumers. Producers do not receive the necessary signal that more products should be supplied, especially if one area of the country is affected more relative to another, such as after a natural disaster. We should allocate more resources to those areas affected, bringing their prices down and increasing prices in other places to signal the relative scarcity. While we are all suffering from this pandemic, maybe the area first affected or areas of more cases should have had more hand sanitizer or wipes supplied to them. However, without the right price signals, how will we know? People hoard (I dislike this term almost as much as price-gouging) because they have been incentivized to do so. The product is still cheap, and so they buy more than they need in anticipation of higher prices or shortages in the future. However, higher prices are more effective at encouraging people to purchase only what they may require, or can afford, than the pleadings of government officials.
We are told that business people should not be greedy during times of crisis and not engage in profiteering. What exactly does that mean? Allowing markets to create the right signals does not necessarily imply excessive profits (if we even know what the means). The price signals and profit opportunities will only lead suppliers to find ways to make the product more available and drive down prices faster. We can debate about whether individuals like the man in Tennessee who drove all over the state purchasing hand sanitizer and other products to sell at a higher price are simply responding to arbitrage opportunities. I would argue that this is also an unintended consequence of price gouging laws creating unnecessary secondary markets where people attempt to raise prices, and sometimes engage in unscrupulous behavior.
Are rising prices and profiteering the only way that businesses respond to a crisis? If you ask politicians, most journalists, and even your neighbors, they would probably say yes. Adam Smith in the Theory of Moral Sentiments wrote that people not only want to be praised but praiseworthy. High prices can motivate people to be praiseworthy. (David Henderson spoke about doing just that in his recent AMA.) Business leaders and entrepreneurs are often on the front line of providing goods and services during a crisis. A few examples include Budweiser switching their production from beer to water following Hurricane Florence to send to victims in North Carolina, South Carolina, and Virginia. Short-term rental giant Airbnb was able to use its network to provide free housing to people during Hurricane Dorian when hotels could not accommodate all the individuals needing shelter after evacuating their homes. Finally, in the current crisis, online platforms such as Zoom are providing access to their product for free so educators can teach online. Still better, entrepreneurs are adapting to the circumstances to help solve problems as in the case of the distilleries that are turning high-proof alcohol into hand sanitizer. Chad Butters brewery founder stated “The right thing to do is support this community by providing something that is in desperate need. We’ll flood the valley with hand sanitizer and drive that price right down.” Whether he fully understands it or not, high prices are doing exactly what they should be doing in this situation- moving resources to where they are most valuable.
What is the best thing we can do in a time of emergency or crisis? We can, of course, be kind to each other; businesses and individuals can engage in philanthropy, but more importantly, we can let markets function to provide proper price signals and allocate resources where they are most desired. If you think that price gouging is a problem or unethical then consider Matt Zwolinski’s argument to the contrary. More importantly, when you are staring at the empty shelf in the store, ask yourself are the low prices, the threats of legal action, and the pleading not to hoard by state officials truly helping to solve the problem?
Peter Calcagno is Professor of Economics at the College of Charleston and Director of the Center for Public Choice & Market Process.