[posted with the author's permission. ]

1998 Karen Selick T

here’s A shorter version of this article first appeared in the Globe and Mail on January 24, 1998.  This longer version appeared in the April, 1998 issue of The Freeman.  You may download a copy of this article for private use, provided you leave this copyright warning attached.   However, the distribution of multiple copies, electronically or in hard copy, or the use of this article for any commercial purpose, is a violation of my copyright.  For permission to reproduce this article, contact Karen Selick.  

There’s Some Good in Gouging

The great ice storm of January, 1998 left millions of residents of Quebec and eastern Ontario without electrical power, some for several weeks.  The storm itself was unprecedented, but it brought with it a phenomenon that’s all too familiar in emergency situations:  complaints of price "gouging" by merchants.  Candles, formerly $1 a box, were marked up as high as $4, reports say.  Prices temporarily skyrocketed for batteries, firewood, propane, gasoline, bottled water and a host of other items.

"No one should be permitted to profit from the misery of others," people raged.  Canada’s Industry Minister John Manley even suggested that oil companies should be giving away gasoline to customers instead of charging more for it.   The Quebec Consumers’ Association threatened to publish a "Roster of Shame" naming businesses that had been reported as gougers.

The truth is, the sudden, exorbitant price increases that occur in times of crisis serve a useful purpose.  Instead of vilifying the so-called gougers for their greed, we should accept them as important and necessary players in the price system—the system which keeps the economy of a distressed region operating as smoothly and impartially as possible under the circumstances.

Take candles, for example.  Ordinarily, most people have little use for them.  During a power failure, everybody suddenly needs them.  Storekeepers are as much taken by surprise as consumers.  They have only enough candles in stock to satisfy their normal low demand.  Faced with a sudden surge in demand, they have two choices:  continue to sell candles at their normal price, or raise the price. 

If they continue selling at the normal price, they will quickly sell out.  There will be no candles left for those shoppers who are slower than their neighbours in reaching the decision to buy candles.  It won't matter how desperately the latecomers need candles--there won't be any available.

Suppose instead that merchants decide to quadruple the price of candles.  Would-be purchasers will be shocked at the new stickers.  Among those shoppers will be some who already have a supply of candles or some other alternative, such as kerosene lamps, and were merely intending to stock up just for good measure. 

"Four dollars for a box of candles?" they'll say.  "Phooey on that!  I'll just use what I've got first and buy candles later when prices have returned to normal."

Others will say, "I was planning to buy three boxes, but at that ridiculous price I'll just take one."

The result?  More candles will be left for latecomers to buy.  Those who didn't already have a supply, and therefore needed them quite desperately, will be able to find some, even though the price may be steep.  As well, all shoppers (both those who decide to buy and those who decide not to) will have been alerted to the fact that candles are in short supply—something they might not have realized if they had been able to purchase them at the normal price.  They will become more sparing in their use of candles, knowing how expensive and difficult they'll be to replace during the immediate crisis.  Spontaneous candle conservation will occur.  The severity of the candle shortage will be alleviated.

Besides encouraging conservation, price increases play another beneficial role:  they induce a rapid increase in supply.  Storekeepers who suddenly find themselves able to make a huge profit on candles will do their utmost to get in a new supply.  People  outside the stricken region who hear about huge profits to be made on candles will rush to the area with a stock of candles. 

This will further assist in alleviating the severity of the shortage.  As truckloads of candles flow into the area, competition among vendors will soon reduce the price down to its former level—just as it did before the crisis began.

Price increases are simply one method of rationing scarce goods among competing users.  It’s not perfect, but the alternatives are even worse.  Suppose the government had quickly passed a law making it illegal to sell candles at more than $1 per box.  Knowing that they will immediately sell out at that price, storekeepers would be able to pick and choose which customers they wish to favour.  This would present an opportunity to curry favour with local politicians, bureaucrats or other people of influence.  A system that allocates goods by "pull" is surely no more fair than one which allocates goods by price.  In normal times, we call this corruption.

Or suppose ration coupons had been issued for candles, so that everyone became entitled to buy an equal but restricted number at $1 per box. This system would allocate candles to people who don't really need them (those with an emergency supply or other alternatives) and deny an adequate supply to people who need them most urgently (those with absolutely none). A black market in ration coupons would soon develop.  Those who need more candles than their ration coupons permit would end up paying inflated prices for them anyhow—because they would first have to buy black-market ration coupons, then the candles.  The only difference is that the windfall profit would go to those who sell their unneeded ration coupons, rather than to storekeepers.   There is nothing to commend such an outcome as more fair than simply allowing candle prices to rise.   And there is a major disadvantage to this rationing scheme: it eliminates the incentive for vendors and outsiders to rush in with increased supplies.

Is it unfair that some people get to use old $1 candles while others end up using new $4 candles?  Not really.  Everyone knows that candles (or candle alternatives) are a useful thing to have on hand in case of an emergency.  Those who maintained a supply were actually tying up a small portion of their capital, perhaps for years, to give themselves this extra security.  They made the decision to forego the purchase of some other commodity, or interest on their capital, in order to keep a supply of emergency goods on hand.  Compared with those who didn't stockpile any candles, they had already made a financial sacrifice.  While this outlay may be negligible in the case of candles, it could be significant in the case of generators.  Those who chose instead to be unprepared merely took their financial lumps later, in a more obvious and painful way.

Of course, there will always be some people who will complain bitterly about price increases no matter what arguments you present them with.  Canadian newspapers were filled with stories about and letters from ice storm victims who pledged they would boycott merchants who had tried to gouge them.  Consumer anger is as predictable as the so-called gouging itself, and is a factor that wise business people have to keep in mind when deciding what to do during a crisis.  Many customers find it easier to accept being told that the store has sold out of an item than to accept a price increase.  A shortage can be blamed on other consumers, while a price increase is clearly the "fault" of the merchant. 

If merchants alienate regular customers by appearing to take advantage of their temporary misfortune, they might well lose more profits in the long run than what they will make in the short run.  This is why some businesses choose not to increase prices, preferring instead to simply sell out. 

On the other hand, stores that increase prices and thereby manage to keep scarce items in stock might actually gain new customers as shoppers stray from their normal haunts seeking a place that hasn’t sold out.  Like most other business decisions, it’s a judgment call. 

What’s important to remember is that just as customers are under no obligation to patronize a particular store, businesses are under no obligation to fulfill the needs of any particular customer.  Each party exists to serve his own ends, not as the means to the ends of others.  When a transaction takes place, it is only because each side attaches greater value to what he gets than to what he gives up.  Customers certainly seem to understand that they have full ownership and control of their money and can choose not to part with it, but they often seem to forget that business people have equally valid rights of ownership in their candles and should be equally entitled to decide when to part with them. 

  This lawyer is a terrific writer.

For more on the economics of price gouging, see this.