Thursday, April 23, 2020

Price Gouging versus Supply/Demand

When the stay-at-home orders were beginning to be announced and the grocery stores more resembled those in Venezuela compared to our usual over-abundance and toilet paper was in short supply there was serious concern about price gouging.

As I have my own little place on eBay, I have adjusted prices to meet demand; often threading the needle between being competitive and having a viable business.  This made, and admittedly, still makes me wonder, "What the line is between operating in a "free market" and price gouging?"

In the idealized free market, at least what I recall from microeconomics, the price of widgets will settle where the supply v. price and demand v. price curves intersect. If there's excess supply, prices should drop; particularly with commodities (products made by a number of firms and are largely indistinguishable in form, fit and function) like toilet paper.

If supply is limited, or as what I often do at work, design something custom, prices go up. On that end of the spectrum, the price is somewhere between what the manufacturing costs, R&D to design and verify the product and keep the lights on at the company are and what the market can "bear". It's unusual and absurd under normal operating conditions to take a loss unless there's a low risk path to profits that can offset those costs somewhere down the line, e.g. a manufacturing agreement or other applications for the technology being developed.

Then there's demand. If you can't give away your widget, you essentially give it away on price. If you make something people want and everyone wants it, again under normal conditions, you raise the price until people "feel" the price, i.e. they feel their money could be better spent elsewhere. Thus, the price works to balance the supply with the demand. We're seeing this most with gasoline right now (e.g. Fig. 1).

There are very few people on the road and, even worse, manufacturing output is low and as such oil futures plummeted, even turned negative. Gas prices haven't been this low since 2016. On a side note, low gas prices may be good for the consumer, but are also an indicator of a struggling economy as they show less manufacturing and and transport of goods using the fuel.

So what is the line between price gouging and the free market ensuring supply?  There seems to be a bit of a gray area. Prices tend to hover and creep imperceptibly upwards with inflation (although I always seem to notice when Taco Bell raises the price of a chalupa). There seem to be a few delineating factors when gouging will get your politician's attention:
  • Gouging occurs when there are spikes in demand where supply lags (e.g. emergency situations and Elton John concerts)
  • A number of resellers enter the marketplace to profit from items and pricing far exceeds the manufacturer's suggested pricing
  • Gouging is of exceedingly poor form, to the point of legal ramification, for necessities, i.e. drinking water or TP, where resource hoarding is detrimental to other consumers. 
  • Gouging, while frustrating, is tolerated for luxury items, such as video game consoles. This is likely because the purchaser is assumed to have sufficient money for a luxury transaction and they won't die...or have itchy butt, if they don't have it.
This obviously covers a lot of ground. Just like raising taxes, raising prices certainly stokes people's anger. To that end, some states have passed laws to limit gouging in emergencies, on necessities and set maximum price controls.  Some famously gouged items are:

To that end controlling pricing seems to be frowned upon by most economists as it gets in the way of assessing the true value of the items in question. Some of that may be economists just clinging to Adam Smith's invisible hand. Another thought is price controls appear to lack the eloquence of a "natural" system and add an element of chaos/unintended consequences in economic theories. However, it indeed seems that if stores were to set a higher price they could ensure they had stock for those who really need an item.

Such price controlling may also stifle innovation. Wouldn't in the long run a better toilet with good "cleaning" capabilities alleviate the need for having to buy anything at all? Although I do think there was some gouging of toilet seat bidets as well, so it might be better done in less stressful times.

Ultimately, price gouging was and will always be around. I think as kind consumers we need to ask "how much do I really need?". We shouldn't be afraid to live with less and/or ration or share when we hit uncertain times.

As for price controls, I think some regulation is necessary to prevent conditions from hitting extremes and making sure people aren't being forced to choose between life and death (i.e. insulin and ppe). Beyond that, a little "making-due" is probably good for the soul.

If you made it this far, here's a recent article from Harvard Business School on the Matter.

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