Benefits and Drawbacks of Price Gouging
In recent years, our vulnerability to demand and supply shocks has been exposed in a myriad of ways. Supply shocks, characterized by unexpected changes in the supply of a commodity, have most notably been felt during the COVID pandemic, which interrupted production across the globe. In turn, demand shocks were created when commodities such as face masks and hand sanitizers were cleaned out of shelves by consumers who sought to hoard these products, feeding into the very demand shock they were attempting to circumvent. Another example includes the regular shopping sprees before the arrival of a massive snowstorm or hurricane.
Taking advantage of these shocks, companies and stores, in theory, would be able to raise the prices of these goods, knowing that they are incredibly sought after in a time of shock — this action is referred to as price gouging. In practice, the U.S. has enacted price gouging prevention laws to prevent sellers from utilizing this process during a market disruption. However, would allowing this practice during times of disorder lead to a wider distribution of necessary goods? In the article above, Kim provides various instances of this practice in the recent past — particularly including examples from recent natural disasters, such as Hurricane Harvey.
Kim provides a glimpse into both the advantages of price gouging, while also warning of its exploitative nature. According to Kim, the rising of prices that occurs with price gouging helps “to allocate resources efficiently via indicating scarcity” (Kim 2021). Essentially, sellers will take advantage of the increase in prices to move their goods into an area experiencing scarcity, benefitting themselves by being able to sell goods at a marked-up price, while also allocating more in-demand resources to an area in need. Additionally, Kim states that higher prices discourage hoarding behavior, as consumers are less likely to stock up on an item whose price is artificially increased by shock, and thus create a more equitable distribution of necessary commodities. On the other hand, Kim points out that a more equitable distribution does not always lead to a more individually fair allocation (Kim 2021). This is because while a $70 dollar case of water might discourage hoarders from buying up an entire stock, it might prohibit those who have less money from acquiring a basic need such as water.
This positive and negative tradeoff concerning price gouging discussed by Kim can be described using the item and seller matching techniques we have discussed in class. For example, suppose we have price gouging prevention laws enacted. Also, suppose that we typically only have 2 cases of water sold each day in a town — these cases are A and B. This town typically also has 2 buyers of water each day — these buyers are W and X. The cases of water cost $5 each, and each buyer has a value of $5 for each water, so the market clears. Suppose now that the residents of this town hear that a severe hurricane is approaching; demand for water now shoots up, as people worry the supply of it will plummet. If demand doubles, we now have buyers W, X, Y, and Z for only two cases of water A and B. The price of the water has a ceiling of $5, so companies are not incentivized to move into the town to sell, so there only remain two cases of water. If each buyer now has a value of $10 per case of water, we have a constricted set, as 4 buyers will all only want the two cases of water, and no perfect matching can be constructed. Additionally, any one buyer will be willing to buy both cases of water, since they have a value of $10 for each case. This has the possibility of leaving only one resident with all cases of water.
Suppose now that we do not outlaw price gouging. In the same scenario, increased demand stays the same, so we still have buyers W, X, Y, and Z — all with a value of $10 per case of water. However, now we also have two other sellers move into the town, as they wish to take advantage of the increased demand to sell goods at a marked-up price — $10. If we have sellers A, B, C, and D each selling a case of water for $10, then we now have a perfect matching, as every buyer will be able to buy only one case of water (so there are no hoarders), and every buyer has an edge to every seller. The drawbacks in practice, however, occur because we have economic inequality in real life. Suppose we introduce inequality into this example, and Z only is willing to spend $5 of their money on a case of water. Now, with price gouging, only W, X, and Y would be able to purchase the water. For Z to be able to purchase the water, one seller would need to lower their price to $5, which would allow Z to purchase a case of water, and lead to market clearing prices.