Wednesday, October 31, 2012

In praise of price gouging, revisited

There are no laws against price gouging in New Zealand. Nevertheless, there really wasn't very much of it when it really really was needed - after the Christchurch earthquakes.

With the New York hurricane, price gouging is again making the rounds of the Econ blogosphere. Michael Giberson summarises things. Jeff Ely has concocted a scenario in which he thinks gouging worsens outcomes. I'm going to disagree with specific reference to the Christchurch experience.

Ely argues that we can have cases where supply is effectively fixed. Consequently, the only gains we get via gouging are in ensuring that goods are allocated to their highest valued use; we don't get increased supply. In that case, we weigh the gains from improved allocation against the losses to inframarginal consumers who have to pay more. Now, Ely's effectively ignoring producer surplus; he says producer surplus should only count when it can bring forth more supply. The better argument would simply specify that producers have lower marginal utility of income so the transfer is utility decreasing. I don't see why we otherwise would want to say that consumer surplus is so much better than producer surplus.

But, the Ely scenario really doesn't fit hurricanes. You get tons of prior warning for hurricanes and the opportunity to price gouge can bring in plenty of new supply. Not like an earthquake. And so let's go back to the Christchurch earthquakes.

After the February 2011 earthquake, we were in a zero-supply-elasticity world for a few goods, most notably petrol. More petrol was coming, but it wasn't going to be here for a few days. All of the petrol stations on the east side of town were out of commission due to power outages; it was very hard to figure out where you'd be able to find a petrol station with power if you lived in the east. Worse, because everyone knew that petrol was scarce, everyone panicked. If you had a car with half a tank, you filled it up. If you had two cars, you made sure both tanks were full. If you had empty jerry-cans, you filled those up too. A student this year told me that he was working as a security guard at one of the petrol stations after the quake. People were filling up barrels with petrol to keep in the garage. Eventually, the station started enforcing some rationing.

What radio reports we could get in the east noted very long petrol queues at the working stations in the west, with some selling out. We were in South Brighton, no power, a quarter tank of fuel [getting home post-quake took 5 freaking hours in traffic], and absolutely no clue whether our quarter tank would be enough to get us to a working station on the west side of town when we bugged out for a house with working sewerage, water and power.

EVERYBODY KNEW THAT PETROL WOULD BE BACK IN A FEW DAYS.

There were no laws against price gouging. But the petrol stations knew that every single customer would hate them if they were the only station to let prices rise such that supply and demand came back into equilibrium. And so because the stations didn't gouge, we were in a terrible equilibrium where everyone's rational response to the below-clearing price was to hoard, because there was real risk that the stations would run out of fuel. And there was real risk of running out of fuel because of the hoarding. Breaking the hoarding equilibrium would have required a coordinated price hike that both allocated fuel to its highest valued uses and told everyone that there would be fuel available for them in an emergency if they really really needed it. That latter part is crucial - it kills the incentive to hoard.

I take the Roth stuff on stupidity constraints seriously - we can't assume those away.* Any station doing the right thing would have taken a reputation hit that outweighed the private benefits to the station because customers are resentful idiots who do not understand how prices work. If the stations had gotten together to coordinate it, there would have been massive pressure for Commerce Commission action. The second-best alternative, given consumers who are idiots about price gouging, would have been a temporary very large hike in the petrol tax for Christchurch, with money raised being dedicated to earthquake relief. This, I think, is the right response when supply is perfectly inelastic and stupidity constraints bind. I argued for it as soon as I was again able to blog post-quake.** It should be a standing contingency plan for similar emergencies.

If there are big worries about hardship on poorer communities from the price increases, get a helicopter, get a bag of money, and drop the money over the poorer communities while letting prices rise. A better option, if stupidity constraints of another form didn't bind, would be to give everybody an emergency debit card pre-loaded with $200 that would only activate if a state of emergency were declared. But there's awfully strong odds that the folks who'd most need them would lose them or sell them prior to the emergency.

I really think Ely is underestimating just how much value there can be in getting to the right allocative solution, and how a good dose of gouging can break hoarding equilibria.

* He calls it "repugnant markets", where people view some kinds of transactions as being repugnant. When those kinds of preferences prevent efficient trades, I call them stupidity constraints. Semantics.

** Other posts on price-gouging summarised here.

17 comments:

  1. I understand your argument Eric, but I still find slightly icky the idea that only those folk with sufficient disposable income should be able to source goods in times of emergency with unfettered gouging, especially with regard to staples like food and water. I have trouble with the notion that rich folk should be able to eat, and the poor be damned, even though I'd probably be counted as one of the aforementioned rich folk. I'd prefer the artificial intervention of rationing in this situation to the purer market driven outcomes.

    ReplyDelete
  2. "But the petrol stations knew that every single customer would hate them
    if they were the only station to let prices rise such that supply and
    demand came back into equilibrium." Isn't that just capitalism in action?

    Are you calling for a government mandated pricing regime for petrol during emergencies? Anyway, I'm curious how you actually determine the 'market clearing price' in those sort of situations - I expect people will simply sacrifice other non-essential items to get the petrol (e.g. paying the power bill seemed a bit moot at the time), unless the price is really obscenely high.

    If you're going to have a co-ordinated response then surely rationing is simpler to implement and for people to understand - "everyone gets 20 litres" vs "I know it looks like we're screwing you over, but in reality we're simply charging a market clearing price to re-establish equilibrium". In those situations I think people are more accepting of rationing over price-gouging - it seems fairer.

    To steal a quote "people do what is most necessary to them at any given moment" and I think for a lot of people what was necessary in Feb 2011 was to have options and having petrol gave them options.

    ReplyDelete
  3. I'm saying there was a market failure that could have been solved with a temporary price hike. Note that rationing doesn't do much where folks are willing to drive down the road to the next station after getting 20 litres.

    ReplyDelete
  4. yes, well I decided to start price gouging on my home in Christchurch for the earthquake refugees renting. They didn't have to pay anything, their insurance companies did .
    And we would supply home, and power, and wood, and internet, and so on but guess who did the gouging on the electricity and internet, and the wood.,
    And guess what it was like, as who stole things from the house and the dogs and animals who gouged out the wall in the house and guess how much we care about the refugees Christchurch East

    ReplyDelete
  5. I wouldn't expect that price hikes do much where people are prepared to sacrifice other spending in order to get what they consider essential. If we're going to assume people have unlimited time to sit in queues at different stations, can't we also assume they have unlimited funds with which to purchase petrol at expensive prices?

    ReplyDelete
  6. The tankers from Timaru were on deck for a couple days later. How much petrol is essential to get you through a couple days?

    ReplyDelete
  7. Well I guess that depends what you want to do doesn't it? Or what you think you might have to do given the uncertainty of the situation.

    From what I heard some stations implemented rationing themselves whilst I know of one station where the owners had obviously put on their big boy pants that morning and increased the pump prices. Apparently not everyone was afraid of being vilified.

    I think it would be politically unpalatable to hike the duty in such a situation or for the government to be seen to mandate a higher price. Besides as you point out it was only a couple of days and the government had bigger fish to fry at that point.

    ReplyDelete
  8. This seems like an expensive and wasteful use of resources at a time when helicopters and money are probably better spent on other relief efforts, and when rationing would, as Duncan suggested, be more acceptable to the general public.

    ReplyDelete
  9. Unless rationing breaks the expectation of outages, it'll just encourage folks to go from station to station to fill up.

    ReplyDelete
  10. I'd not heard of anybody hiking prices; I didn't see it, but I was stuck in the east from Tuesday through early Friday morning.

    ReplyDelete
  11. Only greedy capitalists ;)

    ReplyDelete
  12. Price gouging is blocked because one-shot economics don't exist. In other words, you can't model any economic transaction as if there aren't long term consequences, because humans evolved to create those very consequences via memory. A supplier that overprices at a moment of great import, is socially penalized by his entire customer base, who *actually prefers a random or inefficient selection in the short term*, because this leads to more predictable commerce in the long term. There's a reason people react so badly to price discrimination -- it's an optimum strategy.

    ReplyDelete
  13. And I am saying that is a horribly inefficient equilibrium in emergencies.

    ReplyDelete
  14. At least Chch handled the situation with a bit more dignity and respect than NYers are capable of.

    As for trying to distribute 'free' gas in such an environment, crazy, that is one sure way of stoking animosity and divison in the mind of the public. After all if you are a govt. dept. you can just put it on the cc and the going rate and have the dept worry about it later.

    Looks to be a lesson on stupidity from the yanks ...

    http://www.nydailynews.com/new-york/responders-gas-article-1.1196180

    http://www.nypost.com/p/news/local/department_of_defense_setting_up_XK9Cli2PXUEFWZC0d8abMM

    http://www.dailymail.co.uk/news/article-2227307/Hurricane-Sandy-Lawlessness-outer-boroughs-New-York-enter-sixth-day-power.html

    ReplyDelete
  15. Exactly, from Chch the port in Timaru is only 2hrs away, which is probably similar to many large cities where it can be a 2hr drive across town from the port.

    In Chch when people headed to the petrol station to fill up 'just in case' was one of the most ludicrous situation I have observed from humanity - of course sitting in a long queue engine idling in such a situation is perfectly rational and totally optimal behaviour from creatures evolved from primiative apes.

    Where were these people going, sightseeing drives?

    Most filled up and went straight back home because there was nothing to do (ie. not much open). Home cleanup generally didn't require a huge amount of fuel for the task.

    ReplyDelete
  16. Sounds like you received an economics lesson.

    ReplyDelete

As I randomly delete anonymous comments, please use a handle. Comments on older posts go into moderation; sorry if there are delays in hoisting your comment from the moderation pool.