The situation is terrifying. A hurricane visits unprecedented devastation throughout a major city, leaving nearly all roads and bridges unpassable, and all rail and air-transportation facilities in ruins. Most electronic means of communication are inaccessible for the foreseeable future. Ditto for water and sewer systems and the electricity grid.
The survivors are desperate. Many are near death.
In the city’s eastern half, the survivors — mad with thirst — pillage all stores and grab as many containers of water as they can carry. Sadly, those unlucky persons not near the front of each mob of looters get no water at all. It’s all gone, possessed now by other, luckier looters. Many of these unlucky looters will soon die of thirst.
In the city’s western half, no looting occurs. But all store owners, their hearts hardened by greed, initially charge exorbitantly high prices for bottled water — prices that are as high as these merchants can fetch but that some people cannot afford to pay. Unsurprisingly, these merchants are condemned roundly, and in language most foul.
These criticisms soon prompt the police to prevent merchants from selling water at prices higher than “normal.” Merchants thus sell supplies of water all at “normal” prices to customers who queue up to buy it. Sadly, those unlucky persons not near the front of each queue get no water at all. It’s all gone, possessed now by other, luckier queuers. Many of the unlucky queuers will soon die of thirst.
We can all agree that, despite the store shelves in both regions stripped bare, the absence of looting in the West is a better situation than the looting-scarred situation in the East. Yet in the West citizens desperate for water fare no better than do their counterparts in the East. In both places some people get water at money prices well below those that would prevail in a free market. (Indeed, in the East, the people who get water pay no money prices at all for it.) Also in both places some people get no water at all and die.
The above tale is told to answer one of the most difficult questions asked of any economist who defends so-called “price gouging” — namely: what if the prices of water, food, or shelter rise to heights that some people cannot afford to pay, thus putting in peril these people’s lives?
Although the realism of such a scenario in modern economies is doubtful, answering this question is nevertheless necessary. It’s also quite challenging — but not so challenging that it cannot be done.
The key economic insight is to recognize the error of supposing that prohibiting “price gouging” in situations in which some people are literally at risk of dying for want of the likes of food and water will reduce this risk. It won’t.
In any region so ravaged by a natural disaster that available supplies are too small to sustain the lives of everyone in the region, by necessity some people will die unless additional supplies are brought in. Preventing merchants from charging money prices that some people cannot afford to pay does nothing to brighten this grim reality. Quite the opposite.
The Similarity of Queueing to Looting
Everyone understands that the looting of stores leads only to an arbitrary distribution of who gets available supplies and who goes without. There’s simply no reason to suppose that successful looters are more worthy or needy than are unsuccessful looters or people whose morality won’t permit them to loot.
Everyone understands also that the distribution of available supplies through looting does nothing to inspire suppliers to bring more supplies into the region.
Yet very few people see the similarity, visible to economists, of queueing to looting. As with looters, there’s simply no good reason to suppose that successful queuers are more worthy or needy than are unsuccessful queuers or people whose time or circumstances won’t permit them to queue.
And if available supplies are so limited that some people must do without and die, no conceivable distribution of these supplies will prevent people from dying.
The gallon of water sold to Jones at a “gougingly” high price saves Jones’s life, but it also results in Smith dying of thirst. If the price of that gallon of water had instead been held down to what politicians consider to be “normal,” it’s possible that Smith — able to afford that lower price and fortunate enough to be near the front of the queue — will get the water and survive. But in this case the unfortunate person to die of thirst will be Jones.
Deaths in these bitter circumstances can be avoided only if additional supplies are brought in. And what most economists understand that most non-economists don’t is that “gougingly” high prices are the market’s means of attracting to devastated regions these vital supplies. If government prevents these prices from rising, the market process is thwarted — which in cases such as this one means that people will perish.
Perhaps some “price gouging” opponents worry that merchants in devastated areas will withhold from the market some stocks of vital food, water, and shelter in order to raise prices arbitrarily high. The imagined horrific result is that individuals who cannot afford to pay the high prices will die despite the existence of untapped stocks of life-saving food, water, and shelter.
But in fact any such withholding is highly unlikely. The reason is that merchants earn nothing on goods left unsold. And the familiar (to students of economics) cases of downward-sloping marginal-revenue curves intersecting marginal-cost curves at quantities that yield “monopoly” prices is here not a revealing model of reality. In these natural-disaster situations, because all supplies are assumed to be already in merchants’ hands when the disasters strike, there are no production costs to consider. The cost to such a merchant of selling a bottle of water to Smith is the price that this merchant expects to fetch for that water from Jones. If neither Jones nor any other buyer is desperate enough to purchase that water at a price as high as Smith is willing to pay, the merchant will sell that water to Smith.
Because there’s little reason to believe that sellers in such situations cannot and will not “price discriminate” — that is, sell units of the same good to different buyers at different prices, depending on each buyer’s willingness to pay — there’s little reason to believe that sellers will long withhold from the market goods for which people are willing to pay some positive price.
It’s possible to construct an economically coherent story in which merchants in such desperate conditions indefinitely withhold vital supplies in order to jack up prices, with the ultimate result being that some people die. What must be assessed, however, is the realism of such a story compared with that of the likely consequences of prohibiting “price gouging.” And when such a comparison is done, the damage from prohibitions of “price gouging” is exposed as the more realistic and dominant concern.
The reality is that people in such a situation are so desperate that they’re willing to bid prices sky high. And allowing prices to rise to heights that accurately reveal the intense desperation of the situation is the surest means of encouraging additional supplies of vital goods to be rushed ASAP to the area. Therefore, it is precisely when people are at genuine risk of actually dying for want of the likes of food, water, and shelter that the case against prohibitions on “price gouging” is strongest.