Market signals, including price increases, allow resources to be allocated where they’re needed most.
Market signals, including price increases, allow resources to be allocated where they’re needed most.
F acing surging prices amid a global pandemic, Kansas attorney general Derek Schmidt told reporters last week that his office intends to prosecute profiteers and “prevent opportunistic greed from overcoming the public need for necessary virus-response products and services during this time of emergency.” New Jersey’s lead prosecutor, Gurbir Grewal, struck a similar tone, warning corporations that “price-gouging laws will be strictly enforced to protect consumers trying to stay safe and take measures to protect themselves and their loved ones from the spread of the disease.” In both cases — and many others springing up in states and localities across the country in response to the coronavirus outbreak — legislators and prosecutors misunderstand how prices are set in a competitive market.
As consumers panic about COVID-19, firms are facing a sudden surge in demand for goods such as hand sanitizer and surgical masks. The consumer sentiment driving the increase demand doesn’t have to be rational to require firms to change their behavior; the extent to which consumers stock up in anticipation of a panic is often proven senseless in hindsight, but firms nevertheless have to react to the change in market conditions to meet the demand. If the number of buyers willing to pay the prevailing market price for a given product increases (for whatever reason), firms operating under conditions of scarcity are incentivized to raise their prices to efficiently allocate the existing supply of their good or service to those consumers with the highest willingness to pay.
What is the alternative? If prices remained the same as they were before the surge in demand, shortages would ensue. Instead of scarce resources being allocated based on a consumer’s willingness to pay — which forces consumers to economize and tends ultimately to bring prices down by incentivizing firms to increase supply — the allocation of those resources would be determined by random and capricious factors, such as a consumer’s physical proximity to a store. Raising prices is the natural response of firms operating under conditions of scarcity to a sudden and unexpected increase in demand.
The unintended consequences of price controls have been confirmed anecdotally as well as in empirical literature. Take, for instance, the study published by three scholars in the Journal of Competition Law and Economics who examined the merits of proposed price-control laws in the wake of Hurricanes Katrina and Rita. In the immediate aftermath of the hurricanes, federal lawmakers were considering whether to implement price controls on gasoline and other resources; they ultimately declined to take this step. The researchers reviewed the historical data on gasoline price hikes and found that “price increases were due to the normal operation of supply and demand and not price manipulation.” Upon reviewing the body of gasoline price-control studies, the group found that “neither consumers nor the economy benefit [from price controls], because the apparent monetary savings to consumers are transformed into costs of waiting or other forms of nonmarket rationing that exceed the monetary savings.” Through econometric analysis, they estimated that the “economic damages would have been increased by $1.5–2.9 billion during the two-month period of price increases” if the federal government had instituted price controls.
As this study suggests, placing price controls on gasoline — or, in our case, hand sanitizer and surgical masks — mutes the market signals that allow for resources to be allocated where they’re most needed. As economist Michael Giberson writes: “If you cap price increases during an emergency, you discourage conservation of needed goods at exactly the time they are in high demand. Simultaneously, price caps discourage extraordinary supply efforts that would help bring goods in high demand into the affected area.” Without the price system’s built-in incentives for consumer restraint (forcing consumers to economize in response to price increases), artificial price controls allow consumers to hoard goods and sell them for truly obscene prices on secondary markets.
The premise embedded in laws against “price-gouging”— that firms can raise prices on their goods in a vacuum, unmolested by the constraints of scarcity or their competitors — often bears no relationship to the actual environment in which firms operate. In a market with many buyers and sellers (such as the market for hand sanitizer), one firm cannot wantonly raise its prices as though competitor firms do not exist. If CVS, for instance, were to sell Purell for $8.50 while the Rite Aid across the street sold it for $3, CVS would lose all of its business to Rite Aid, to say nothing of the ill will it would engender among its customers. If firms in a truly competitive marketplace are raising prices on a good or service, they’re almost certainly doing so as a response to forces that go far beyond the “greed” of the particular sellers involved. In response to the suggestion in 2017 by University of Chicago economist Richard Thaler that the government should prohibit price gouging, Don Boudreaux made this very point, writing at the blog Café Hayek:
Prof. Thaler argued that firms that raise prices during emergencies anger consumers and, as a result, reduce consumers’ likelihood of doing business with these firms in the future. This argument is undoubtedly correct. 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.
To recognize this fact is to recognize that firms are subject to scarcity and competition, stubborn realities that obtain whether or not we’re in a global pandemic causing mass panic. Do I wish it were not so? Sure. But as Thomas Sowell reminds us, “reality is not optional.”