Updated: Mar 16
Would CBS run a headline that read "$2 for a $4 case of Water: Store Owners are Getting Hosed Due to Low Demand for Bottled Water." - No, they wouldn't. Because the public would all collectively agree that that "$4" case of water is now obviously worth only $2 due to the low demand.
Each time a hurricane hits the United States, we are bombarded with reports of something known as "Price gouging." What is this common phenomenon? Those who put little thought into economics, and more thought into emotions, will say that price gouging is the raising of prices on necessities at a time when people need them the most. Most often it is at a time when people are buying things they cannot live without in the event of a major disaster.
Take this headline from CBS as an example.
Let me first say that I understand the emotional reaction to this. It can, on the outside, look as if sellers are "taking advantage" of people in need, at a time when they have no choice but to the buy the products at whatever price they are available. In fact, it might be true that some individual business owners are taking advantage of the ability to reap higher prices than normal on basic necessities. My emphasis, however, is going to be placed on the economic implications of these actions, and the end result they produce.
Back to that original headline; "$9 for a $4 case of water: Florida hit by price gouging ahead of Hurricane Dorian."
What does it mean for a case of water to be worth $4? Most of us put little time into researching all of the expenses that go into the material cost of the case of water. In addition, we put little effort into finding out why that case has been deemed "worth" $4. The actual cost of the case to the store owner might have been $2.50. Why then, is it worth $4? It's a very simple answer: That's what people will pay for it.
We put little thought into the fact that everything we use on a daily basis has been priced in a society-wide auction. You know how an auction works. The auctioneer holds up a product, and the public increases the price they are willing to pay for that product, until the top price is reached. It might not be obvious, but that same process has been used in every product we use on a daily basis. It hasn't happened on an individual level, but it has in fact happened. A product is being offered, and the seller has sought out the highest price they can receive for that product.
Why then, was the case of water worth $4? Simply because that was the highest price the public would pay for it. Why is your iPhone worth $1,000? Because that's the highest price Apple could get for the phone, without pushing too many buyers out of the market. Why does gas cost $2.39/gallon at my local gas station? Because that's the highest price the station owner can get for the gas. Here in Nashville, if that local gas station owner were to raise the price to $5 per gallon, they simply would not sell any gas. People in Nashville do not deem gas to be worth that much, and there is too much competition in the market for that kind of price hike.
There are two sides to the auction, by the way. The seller is trying to get the highest price for their product, and the buyer is trying to get the lowest price for that same product. These two work hand in hand together, negotiating the market price for whatever that product may be. If the gas station raises it's price to $5/gallon, you may not shop at that gas station. The station is then incentivised to lower it's price to $4.50. If you do not shop at that station still, they may lower the price to $4. So on, so forth. There's an eternal struggle between buyer and seller, all unknowingly following the basic laws of supply and demand.
If it's considered "gouging" by the gas station when it raises prices in reaction to high demand, should it also be considered "gouging" by the consumers if the price is driven lower in times of lower than usual demand? Would CBS run a headline that read "$2 for a $4 case of Water: Store Owners are Getting Hosed Due to Low Demand for Bottled Water." - No, they wouldn't. Because the public would all collectively agree that that "$4" case of water is now worth $2 due to the low demand.
Supply and Demand
We all know about supply and demand. If there are 10 iPhones, and 100 people who each want an iPhone, what is likely to happen to the price of the iPhone? If there is suddenly an influx of iPhones into the market, equaling now 150 iPhones for 100 people that each want an iPhone, what is likely to happen to the price of the phone?
The important function in that above situation is the price of the phone. If there is a larger than needed supply of phones, the price will go down. That lower price leads phone producers to slow down the production of phones. Why? Because they are receiving less money for the product, so they are going to focus resources elsewhere. The lower price leads to a lower amount to be produced.
On the flip side, a higher price sends a very different signal to the producer. When they see that they are receiving a high price for a product, the producers are more likely to focus resources towards producing more of that product.
All of this seems trite when discussing the production of an iPhone. An iphone surplus or shortage is considered a "first world problem." The situation changes when you replace the word "iPhone" with "case of water." While the raising of prices on something as necessary as water may trigger negative emotions, the result of this action is clear. A price fixed at a lower cost will lower the incentive to produce more of that product. A higher price will incentivize more production. When we're talking about water, that's a pretty important point.
During times of natural disasters, things like water, canned goods, gasoline, generators, etc., become highly important to a larger amount of the population (higher demand). Over the last week, you no doubt read reports of "price gouging" but you might have also seen pictures of people filling up storage containers with gasoline in preparation for the storm.
Prices have a very important role in distributing resources. What's the most important thing in the event of a disaster? I would say that it's the ability to get out of harms way, or to find a way to survive when the infrastructure falls apart. What is the result then, of the prices being held at a lower price, even when people are buying more than enough gas to stay alive? The result is something known as a "shortage."
A shortage occurs when more of a product is consumed or desired than the amount supplied. My argument would be that allowing the prices to rise would perform two major duties:
1. It would ensure that consumers are only buying the necessary amount of each product. Only enough to "weather the storm." This would leave resources available for more people to get what they need.
2. It would incentivize the production of more of that product. In this case, it would incentivize producers to bring more supplies into the affected area, and it would incentivize more store owners to stay open during the disaster.
We covered number 1 in the earlier paragraphs with "supply and demand." Number 2 is as important, if not more important.
The public fails to realize that resources are scarce. The gas station does not have an unlimited amount of gas, and the store does not have an unlimited amount of water. What happens when they run out? It can be hard to get a supply delivery when the roads are closed between the distribution center and the store. It can be hard to replenish supplies when distributors are unlikely to put their drivers in harms way. Many of those problems are solved by offering a higher prices for the goods needed. Drivers may choose to drive in dangerous conditions. Store owners may choose to work in dangerous conditions.
If you were a local store owner, would you ask your employees to stay at work during a hurricane? If you did, would you agree that those workers deserve higher pay? If you decided to keep the store open on your own, would you do it for the same pay you normally receive under safe conditions? When thinking about it under in this light, it can be easy to discern why stores might need higher payments for normal goods to remain open.
The result of price controls has been well documented. It's called a shortage. Shortages are only likely to happen in times that prices have been artificially held lower under the guise of preventing "price gouging." There are shortages that occur when the goods needed are truly exhausted, but the question must be asked, would those goods have been exhausted at a higher price? Would suppliers have provided more at a higher price? Which result actually helps those in need, and which result pretends to help those in need?
When thinking about pricing you must always remember- Each seller is ALWAYS charging the highest price they can get for their product. Apple is doing it right now with their phones, your gas station is doing it right now with their gas, your grocery store is doing it with cereal, Ford is doing it with their cars. On the flip side, buyers are always buying things at the lowest price they can in all of those markets. All that changes is simply the price that people are willing to pay. During a natural disaster, that price goes up. That's not price gouging, it's simply supply and demand.