“Price Gouging” is Scarcity Extended to the Individual

The price gouging explanations have been back for weeks, with the usual, and correct, defenses of the market and how it allocates scarce resources during a crisis. Higher prices are a result of higher demand immediately after a crisis, with a greater disequilibrium from supply. Factors of production cannot produce more of the specific product immediately, so a higher price rations the available supply. This is just a reflection of the greater scarcity of the good. 

The usual market defense is that “anti price-gouging laws” cause shortages, which they do. But market forces do more than prevent a shortage, as they primarily prevent the needed resource from being used for unimportant purposes, which would not make any sense in a crisis. Most would agree that it would not be rational for hand sanitizer to be used for a backup bottle on top of several others stock piled in a family’s basement, when it is immediately needed to prevent the spread of COVID-19. 

The significance of price gouging is how it prevents not just shortages, but marginally less important uses of the scarce product in individual households. When a catastrophe makes a product extremely high in demand when the supply does not have time to catch up, the market allocates that product to the uses related to catastrophe. After a hurricane the market allocates building materials to rebuilding the affected area. After the coronavirus outbreak, hand sanitizer is allocated to prevent COVID-19. 

For context, every individual has a subjective value scale in which they will allocate a given supply of a product to various uses. A family’s value scale for hand sanitizer might look something like this: 

  1. 2 units for the family to prevent the virus 
  2. 1 unit to provide to elderly parents 
  3. 10 units to store for later
  4. 2 units for the office

Based on this value scale, if 5 units of hand sanitizer are available in supply, 2 units will be used for the family, 1 will go to the parents, and 2 will be stocked for later. If the available supply were reduced to 4, the least marginally important use will be cancelled, 1 less unit of hand sanitizer to store. 

Now families will spend money on hand sanitizer, so their supply of hand sanitizer is rationed in the limited number of dollars available. The value scale would then consist of how many dollars they are willing to spend on hand sanitizer versus other goods available, and then how much hand sanitizer they are willing to buy for uses along their scale of values. If each unit is priced at $1, and the family has $5 available, the result would be the same as in units. If the price of hand sanitizer was $2, the family would cancel the relatively less important use of a unit for the parents, and only buy 2 units to keep the family members safe from the virus. The main point is that if the price of hand sanitizer increases, individuals will not make the trade for the least important marginal use. 

So when an unforeseen catastrophe hits the economy, scarce resources are needed immediately to alleviate the pain. With the coronavirus outbreak, hand sanitizer prevents the spread of the virus. The price rises to what are called “gouging levels” and families only buy units for the most important marginal use, preventing COVID-19. Just as a rise in the price of building materials after a hurricane would assure that they are used only for rebuilding destroyed homes. Similar to a rise in the price of land which assures that it is allocated to the most efficient use in the future. 

Anti- price gouging laws are so irrational that they prevent economizing of a scarce good when economizing is needed the most. So backwards that some families will keep hordes of hand sanitizer while others will be unable to find single units to prevent COVID-19. When the price is forced by the government below the market level, buyers that arrive at an earlier point in time will buy hand sanitizer as they would for all of their marginal uses as in normal times, or more because of shifted preferences after the virus outbreak. Buyers that arrive later will get nothing. 

Allowing free pricing in a crisis is not simply preventing the shortage that would otherwise be caused, but reflecting the scarcity of a product, and the necessity that it be saved for its most important use, down to the individual buyer. Anti-price gouging compulsion indeed hurts the consumer by denying a scarce product that they could otherwise buy at a higher price for an extremely important use. It disincentives the increased production of the product to alleviate the temporary disequilibrium to supply and demand. But most irrationally, it is the denial of scarcity at the individual level. 

Image: Brianna Clark| Flickr

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