In Praise of Price Gouging

As I have pointed out any number of times, when supplies of something are short, you can allocate them either by price or by rationing.  Robert Rapier, via Michael Giberson made the point that combining shortages with tough state price-gouging laws inevitably led to rationing and long lines:

Someone asked during a panel discussion at ASPO whether we were going
to have rationing by price. I answered that we are having that now. But
prices aren't going up nearly as much as you would expect during these
sorts of severe shortages. Why? I think it's a fear that dealers have
of being prosecuted for gouging. So, they keep prices where they are,
and they simply run out of fuel when the deliveries don't arrive on
time. If they were allowed to raise prices sharply, people would cut
back on their driving and supplies would be stretched further.

Neal Boortz made the same point yesterday, as the gas shortages in the southeast dragged out (unsurprisingly) for a second week:

nearly 200 gas stations in Atlanta are being investigated for price gouging.  Don't investigate them!  Reward them!  Price gouging is exactly what we need!  It should be encouraged, not investigated....

The real problem now is panic buying.  People will run their tanks
down by about one-third and then rush off to a gas station.  Lines of
cars are following gas tanker trucks around Atlanta. The supplies are
coming back up, but as long as people insist on keeping every car they
own filled to the top and then filling a few gas cans to boot, we're
going to have these outages and these absurd lines. 

So, how do you stop the panic buying?  Easy.  You let the market do
what the market does best, control demand and supply through the price
structure.  The demand for gas outstrips the supply right now, so allow
gas stations respond by raising the price of gas .. raise it as much as
they want.  I'm serious here so stop your screaming.  The governor
should hold a press conference and announce that effective immediately
there is no limit on what gas stations can charge for gas.  I heard
that there was some gas station in the suburbs charging $8.00 a
gallon.  Great!  That's what they all should be doing.  Right now the
price of gasoline in Atlanta is artificially low and being held down by
government.  That's exacerbating the problem, not helping it.  Demand
is not being squelched by price. 

As the prices rise, the point will be reached where people will say
"I'm fed up with this.  I'll ride with a friend, take the bus or just
sit home before I'll pay this for a gallon of gas."  Once the price of
a gallon starts to evoke that kind of reaction, we're on our way to
solving the problem.  When gas costs, say, $8.00 people aren't going to
fill their tanks.  They also aren't going to rush home to get their
second car and make sure it is filled up either ... and you can forget
them filling those portable gas cans they have in the trunk.  Some
people will only be able to afford maybe five gallons!  Fine!  That
leaves gas in the tanks for other motorists.  Bottom line here is that
people aren't going to rush out to fill up their half-empty tanks with
$8.00 gas.

Here is something else to think of about lines and shortages.  What is the marginal value of your time?  I think most people underestimate this in their day to day transactions.  Some will say it is whatever they make an hour at work, and that is OK, but I will bet you that is low for most folks.  Most folks would not choose to work one more hour a week for their average hourly rate.  Start eating into my free time and family time, and my cost goes up.  That's why overtime rates are higher.   

So let's say an individual values his/her time at the margin for $25.  This means that an hour spent waiting in line or driving around town searching to fill up with 10 gallons raises the cost by $2.50 a gallon.  And this does not include the fuel or other wear on the car used in the search.  Or the cost of that sales meeting you missed because you did not have the gas to get there.  So an anti-gouging law that keeps prices temporarily down by a $1 or so a gallon may actually cost people much more from the shortages it creates.   

  • http://dullgeek.blogspot.com mjh

    I made similar comments here:

    http://dullgeek.blogspot.com/2008/09/gas-shortage.html
    http://dullgeek.blogspot.com/2008/09/re-gas-shortage.html

    One of my points: When there's a shortage, price caps don't allow for a smooth transition from high supply to shortage. You simply run out. People don't get a chance to figure out how they're going to work around the shortage. The supply just disappears one day. Whereas when the prices rise, people can stop other (less important) consumption in order to give themselves a little time to figure out how to conserve on the commodity that's in short supply. Price increases allows people to link things that have relatively inelastic demand with something that has higher elastic demand. This gives people time to think and devise a plan.

    What price caps do is create the illusion that there's no supply disruption until supply runs out. And then (rather suddenly) the price jumps up from $4/gal to infinity. And everyone's stuck trying to get a commodity that's gone with very little time to figure out an alternative.

  • nick d

    Heh, if gas was $50/gal there, you can guarentee every person in the southeast would be personally driving tanker truck to Georgia and selling it out of the trailer! Hell, I'd drive it in from California! Atlanta would be awash in gas in less than a day.

  • http://www.tinyvital.com/blog John Moore

    This seems to be one of these arguments that one just cannot win in the public sphere. I don't understand why - perhaps it is because of our state run educational system and our uneducated media.

    But whatever it is, when someone starts "gouging," all hell breaks loose. In fact, the ideasphere in this area is so distorted that it appears to make business sense NOT to raise prices too high, simply because it will tick off customers who don't understand the issue. That may explain the experience you had in Atlanta where you were limited in how much you could fill up.

    Having a pregnant daughter in Atlanta, I would go for "gouging" any time to make sure she has the fuel when she is going to need it! Of course, I'd go for it anyway.

    Does anyone remember the phony gas shortgage we had here in Phoenix when the only pipeline providing the approved EPA blend shut down? "Gouging" would have ended the shortage in a flash. But instead, we had politicians vowing to do whatever was in their power to punish "gougers."

  • ccoffer

    Gas here in my part of GA should be 6 dollars a gallon. That way no one would be hoarding gas. At the same time, anyone wanting to sell it for half that price would be free to do so. The only difference would be that some folks (like me) would have an alternative to sitting in a gas line. Kroger, QuickTrip and others are not running out that often, but that is only because they have nationwide distribution networks that smaller vendors do not have.

    Sonny Perdue is an assclown.

  • http://www.QandO.net Bryan Pick

    Heck, I nearly got stuck in Nashville for this very reason. Got angry, wrote a blog post about it.

  • Rob

    I live in Charlotte, NC. Today, is the first day that the lines at any given gas station were not extending out onto the road, subsequently causing congestion.

    Another point, which I haven't seen made much is that margin of profit per gallon of gas is not very high for these gas stations. Most gas stations rely on the convenience store to sell cigarettes, beer, snacks, drinks, magazines, etc. I imagine these gas stations are probably making less money a week when they run out of their 2 weekly shipments of gas in a matter of hours.

  • Bob Smith

    Heh, if gas was $50/gal there, you can guarentee every person in the southeast would be personally driving tanker truck to Georgia and selling it out of the trailer!

    You'd think so, but I bet that won't happen. Because Congress allows local and state environmental regulation to override federal regulation, the US gasoline market is extremely balkanized. When an area starts to run short of gas, it is often the case that gas in the surrounding areas cannot be shipped in because it doesn't meet local regulations for gasoline. Pretty much the entirety of California uses special gas blends that prevent gas from outside the state from being sold there, and worse the various metro areas use different blends from each other. As you would expect, supply shocks are common in CA.

  • http://www.villa-vacation.com/home-rental-6032.htm frank

    A related issue: In Europe (and here in Veracruz, Mexico), every neighborhood, nearly every block, has a small grocery store. These stores don't have big parking lots, nor buildings. They look just like the houses around them.
    You don't HAVE to get in your car for every little need; you walk.
    Due to the USA's mania for "zoning" out small businesses from suburban areas, car use is mandatory and wasteful.

  • http://genericconfusion.blogspot.com Greg

    Frank,

    Those small grocery stores exist in America, too. They're in the higher density inner cities, and are frequently criticized for their high prices, poor selection of healthy foods, and poor quality fresh foods (to the extent they have them at all).

    Fortunately, most people have access to larger stores with lower prices, greater selection, and convenient one-stop shopping. We even have destination shopping options, like factory outlet stores, which may be an hour's drive from cities, but offer some serious bargains.

    I'd like to see codified in law a description of what is by definition not price gouging, to stop the lawyers. Stores should be able to raise their prices of in-demand items by 100% or more without fear of being sued, and we'll rely on competition to keep the higher prices just high enough to equalize demand. I propose the following standard for what is not gouging: for a 20 ounce bottle of soda, the ratio of the average price in the area's stadiums and amusement parks to the average price in Wal-Marts and grocery stores. Because if a 500% margin for this item isn't "gouging," then it should be true for all products.

  • zjohna

    "Stores should be able to raise their prices of in-demand items by 100% or more without fear of being sued...."

    Horse-squeeze. Stores should be able to charge whatever they want, whatever the market will allow. Government has no more business setting prices than it does setting wages.