Confronted with the looming menace of the coronavirus, consumers around the world are starting to panic-purchase essentials and supermarkets are running out of stock. In other words, there has been an increase in demand for staple goods. Without outside intervention, we should see a short-run increase in prices. However, many state regulations are likely to prevent that from happening.
Why? Because that might be price gouging, which is either explicitly illegal or widely considered unconscionable.
Price gouging is the practice of pushing up prices in a manner that is deemed exploitative. What constitutes exploitative? Depends on the views of regulators and the courts. But the basic idea is that the “exploitative” practice of pushing up prices in the face of an emergency is deemed to be morally reprehensible and should be stopped.
Preventing so-called price gouging would be a mistake, however.
Generally speaking, markets do a pretty good job of allocating scarce resources. Profits reward businesses that efficiently produce the stuff we want, while losses punish businesses that produce wastefully or don’t produce what we want. As long as there is free entry and exit, entrepreneurs will tend to follow the profits and run away from the losses, minimizing waste and providing the self-regulation of competition.
This competitive process simultaneously relies on accurate prices and ensures that price inaccuracies are self-correcting: If a shop sets their prices too high, there will be no customers. Too low, and they might take losses or keep running out of stock. In a free market, a profitable firm that can set high prices will eventually face the threat of new entrants copying them at lower prices (like DiDi and Lyft copying Uber, which itself challenged the legally protected taxi monopoly).
So when there’s a sudden shift in demand, it’s important that we let the prices rise. Why? Because the higher prices encourage supermarkets to increase deliveries and ensure that stock is replenished. Crucially, it also rewards supermarkets for keeping stores open when international supply chains are being severely disrupted by the coronavirus, pushing up costs. It also encourages entrepreneurs and other businesses to produce the consumer goods we want and need right now.
The increase in the price is also important to ensure that consumers are behaving efficiently. The increase in the price of canned goods tells the consumer to save their canned goods for the future rather than casually crack them open when they can’t be bothered cooking. The increase in the price of paper towels means that you might clean up your spills with one sheet rather than three.
The sheer brilliance of the price system means that all of this resource management happens automatically. No wise bureaucrat needs to come up with a plan, no clumsy politician has to get involved, no heavy-handed intervention is needed.
Many people brush this line of reasoning aside. “It’s all well and good for the classroom blackboard, but the real world is more complicated than this idealized nonsense!”
Unfortunately, the real world is, indeed, more complicated. It’s so complicated, in fact, that our efforts to “outperform” the cold-hearted price system inevitably leads to disaster. Excessive minimum wage laws have devastated poor communities, rent-controls create monstrous housing shortages, and binding price-ceilings lead to lasting shortages of necessities and black markets.
Have we forgotten the impact of price controls on the 1970s US gas shortage? The bottom-up nature of the price system can take into account millions of consumers and the vast array of constraints on producers, without needing any top-down supervision.
If price-gouging laws prevent prices from going up, we risk seeing extended shortages of necessities, causing lines and rationing, which are not only phenomenally wasteful, but also incentivize black-markets, criminal behavior, and even violence.
While price controls often are implemented in the name of protecting the poor and vulnerable, few would dispute it tends to be the poor and vulnerable who are disproportionately harmed by shortages and rationing.
Rationing tends to favor the rich (through black markets), the most informed, or those who are lucky enough to have the right connections. Better that we end the shortage quickly through rising prices than extend the misery with prolonged shortages. Without higher relative prices, entrepreneurs will receive no incentive to risk their time and money on eliminating these risks.
In fact, the community would be better off if the government provided one-off grants to the poor and let prices rise rather than inhibit the price increase. The change in prices is what generates the change in producer behavior, and that’s what we need to see happen.