Monday, September 6, 2010

In defense of price gouging

I tweeted early on in the quake that I wondered whether supermarkets would implement efficient pricing on water and batteries, hiking prices to meet the surge in demand.

I wasn't really wondering - they never do.  Why?  Because most customers aren't economists. The dairy owner who gives away all his stock by 8 am after the quake draws praise; the guy who makes sure there's something left for folks showing up at 2 in the afternoon, not so much.  Businesses know that customers seem to get angry at the store for price hikes but angry at the earthquake for shortages; erring on the side of shortages gives the store fewer hassles.

Now, we were lucky in Christchurch.  The water came back quickly, albeit under a boil water notice.  So the losses from holding prices constant were pretty small.  But it could have been worse.

First, it induces allocative efficiency.  In the world where prices remain constant, the first guy to the shelf buys a couple of bottles of water, even if he has plenty at home.  After all, who knows when the water will come back on - days, weeks, months ... who knows?  The radio suggested it could be quite a while.  Same calculus for the next ten folks through the store, then there's none left for anybody else, regardless of whether the thirtieth person through valued the water at a hundred times the first person going through.  If the price jumped enough for folks to notice it, the guy going by who didn't really need it would leave the water on the shelf for somebody who needed it more than him - not out of the goodness of his heart but out of concern for his wallet.  It would be a fine world if we could rely solely on the goodness of folks' hearts - and we've seen an awful lot of such goodness in response to the quake.  But I didn't see any water on any shelves of any stores we went into.  Now, maybe that's 'cause a bunch of folks came in early who needed the water to mix up infant formula, but I don't really think so.  There's only so much goodness to go around.  If the price increases, the folks who can most easily adjust to using less water do so and only the folks who need the water most wind up getting it.  They'll have less cash in their wallets afterwards, but at least they'll have what they need.

Second, it encourages stores to hold excess reserves.  Suppose you're the manager of a supermarket and you have to decide how many bottles of water and packs of batteries to keep in the warehouse.  Space in the warehouse has a high opportunity cost, and water does go off over time.  If you know that you can't raise your prices in a crisis because your customers will resent it forever, you'll keep less water in stock in the back than if you know you can hike your prices.

Third, it encourages folks to stock up before the crisis.  Even the guy who lives next door to the grocery store will keep some supplies at home if he reckons that the price would hike in an emergency.

Finally, it more quickly draws supply into the affected area from places not hit by the quake.

We came out fine on the water front - we didn't even wind up tapping into the emergency supply from the garage.  Looking at that tank kept me thinking about the Wondermark strip copied below.

He ended up looking QUITE the fool at that philosophers' cocktail party.

The water came back on on Saturday for us - about 12 hours after the quake.  Folks without water visited friends with water. A guy down the road had a hose running down to the street with a sign saying "Well water", though I'm not sure that its constant running into the storm drain is quite what the system needed.  Things have worked out so far.

We got pretty lucky.  Initial reports had it that water wouldn't be back for days or longer and that some of the roads out of town were blocked.  If it had taken a lengthy period to get most folks' water back on and to get tankers of potable water to emergency centres, it would have been a shame that the bottled water hadn't gone to its highest valued use.

Walter Block's "Defending the Undefendable" (pdf) is great fun for folks who haven't seen it before.

6 comments:

  1. Thankfully we were able to find a "gouger" of a plumber - running full staff plus anyone else he knew. Had our internal piping repaired less than 8 hours after the quake. He was running the whole show from his iPhone (whilst in the ceiling). We paid more than normal but the hot shower was worth twice what he charged - Mike Munger relates a funny "gouging" story in this EconTalk:
    http://www.econtalk.org/archives/2007/01/munger_on_price_1.html

    A great listen if anyone is still skeptical of the benefits of letting people "gouge".

    - Dennis

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  2. Went to Countdown Bush Inn on Sunday at around 1pm. They were almost out of water, but limiting it to 2 bottles per person. One of the cheaper brands was on special (!?) and all of that water was gone.

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  3. I can't help but wonder; if there is a real social (and flow-on economic) cost to dairy owners in selling water at inflated prices, but there ISN'T likely to be similar costs for a private citizen (when are they likely to need random stranger's patronage again in the future, unless they run for office or something), wouldn't it be efficient for the dairy owner to sell at the original price, and then for the first purchasers to price gouge the stock they've picked up cheaply?

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  4. @Dennis: Will listen once my internet is back to normal, thanks!

    @Charlotte: Rationing is pretty second-best response. The sale water - was it a new sale, or something they were stuck with from their prior sale flyer?

    @Matthew: You're supporting profiteers! I'd expect that transactions costs would mostly stop that.

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  5. "If the price jumped enough for folks to notice it, the guy going by who didn't really need it would leave the water on the shelf for somebody who needed it more than him - not out of the goodness of his heart but out of concern for his wallet."

    This is standard rational decision-making stuff. Generally, this is not how people react in crisis scenarios, however.

    The rational expectation fails to account for the fact that people generally don't respond rationally during times of crisis; human beings, current psychological research suggests, are actually not wired to think this way at all.

    Of course, this is highly dependent upon the individual's perception of crisis, which is largely a very subjective measure.

    If people's cognitive equilibrium is far enough off-kilter, rather than leave the water on the shelf, if the price is too high, they bop the guy behind the counter behind the ear and take off with the water. Actually, if they're off-kilter enough, the price of the water isn't relevant at all, they'll just grab it an run, even if they don't actually need it, because their perception of need is way out of balance with their actual need.

    The free market is great at establishing equilibrium for elastic goods. It's not so great at establishing equilibrium for life-dependencies (or perceived life-dependencies), partially because money itself also loses utility as a medium of exchange in crisis scenarios.

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  6. I just don't buy that somebody would rob the store for a $10 bottle of water that used to cost $1.

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