Is It Really Wrong to Raise Prices During A Crisis?
After Hurricane Sandy, the Attorney Generals of New York, New Jersey and Connecticut announced that they would clamp down heavily on people engaging in "price gouging." But while it may be vaguely illegal, is it really wrong to raise prices during a crisis? By preventing prices from adjusting in response to changes in demand and supply, price gouging laws discourage entrepreneurs from increasing supply, thereby perpetuating the problem they are intended to solve. It's time to rethink these laws.
Hurricane Sandy left chaos in its wake up and down the East Coast. Over 100 people lost their lives. Thousands of homes were destroyed. Millions were left without power. Transportation became a nightmare: roads were flooded and strewn with debris; train tracks became temporary harbors for stray boats. To make matters worse, there was a gasoline shortage. People queued for hours in the cold to fill their tanks with gas, often in vain. As a result, many were unable to make urgent journeys or operate generators that would have mitigated the lack of power. But a few merchants realized they could make a quick buck and raised their prices - offering fuel and other goods to those who would pay more rather than wait in line - and some are now facing prosecution.
On November 5th, New York Attorney General Eric Schneiderman announced, "an investigation into post-Hurricane Sandy price gouging after receiving hundreds of complaints from consumers across the state of New York." New York State's Price Gouging Law (General Business Law 396-r), enacted in 1979 after a severe winter in which some merchants raised the price of heating oil, prohibits merchants from selling goods or services for an "unconscionably excessive price" during an "abnormal disruption of the market."
The law was first enforced in 1985 after Hurricane Gloria struck Long Island. A retailer selling generators was fined $5,000 and forced to restitute customers the difference between the "base" price and the amounts for which the units were sold (which varied from 4% to 67% and totaled around $20,000). This time, most of the complaints are related to the price of gasoline, but some have also related to the sale of generators and various services.
New Jersey's Attorney General Jeffrey Chiesa has also charged at least eight businesses with "price gouging" in the wake of Sandy, and his office has issued over 170 subpoenas after receiving more than 2,000 complaints. One of the businesses cited was a gas station that was charging $5.50 per gallon -- nearly $2 more than before the storm. Meanwhile, a Howard Johnson Hotel charged $119 for a room, when prices before the storm were only $90. In both cases, the proprietors appear to have breached the law prohibiting merchants from raising prices more than 10 percent in cases of emergency. If found guilty, the violators could face fines of up to $10,000 for the first offense -- and $20,000 for each subsequent offense. Like Schneiderman, Chiesa has said he is taking a "zero tolerance" approach to price gouging.
While some merchants were raising prices, New York's Governor Andrew Cuomo ordered the distribution of free gasoline, with predictable results. New queues formed for the free gas, without appreciably reducing the other long lines around the city. It turns out that when gas is free, demand rises. (Of course, the gas wasn't actually free--it was or will be paid for by taxpayers, but let's not quibble.)
While free gas obviously results in new demand that wasn't there before, "price gouging" laws have a similar if less dramatic effect. These restrictions on raising prices during emergencies are supposed to protect consumers from suppliers who might otherwise take advantage of the situation. But some customers are clearly harmed by the price gouging laws--including many of those queuing for gas.
Last Sunday, as I was being driven in a pre-booked car from LaGuardia to Manhattan, I asked my driver how long he had to wait for gas." Two hours," he said. So I asked him how much he would have been willing to pay to get the gas sooner. Initially he said he wouldn't pay any more because that would be wrong. So, I then asked him how much he earns an hour. "About $40," he said. And how much does a tank of gas cost? "$50." And how long does it last? "About a day and a half [12 hours]," he replied. So, having worked out that he earns $36 net of gas costs per hour, I calculated that the opportunity cost--the foregone revenue--of the two hours he spent queuing was $72, so in principle he should be willing to spend up to $122 to fill up his car.
I pointed out that if he were to pay twice the current price for gas, but didn't have to wait, he would net an additional $22. He liked that and agreed he would be willing to pay twice the current gas price not to have to wait. In fact he liked it so much he became rather excited and asked if it would be possible. I said that sadly the law prevents gas stations from raising prices that much - at which point he became despondent again. (His smile returned when I gave him a generous tip and told him it was my way of compensating him for his time queuing.)
One of the main reasons for the gas lines was that gas stations lacked power to pump the gas. A few, such as those operated by Hess, had generators. Those stations were clearly at a competitive advantage--they were able to sell gas! And if there were no price controls, they might for a while have charged more for their gas. But if there had been no price controls, other gas stations would have brought in generators--since in the short term the higher operating costs would have been more than offset by the higher prices they could have charged for gas. The number of stations selling gasoline would have risen rapidly and the increase in competition would have driven down prices. Meanwhile, during the short period when prices were raised, those who most needed gas, for their generators or taxis, would have been able to obtain it.
For hundreds of years, philosophers quibbled over the "just" price of a good. The question was finally settled by Montesquieu, who said it was the price at which a willing buyer and willing seller transact. In other words, the market price. Nobody has yet offered a better definition. It's time for politicians to recognize what philosophers and economists have known for centuries and end these unjust laws on "price gouging."