Whenever there is a natural disaster, we see two things: the best in human generosity, courage and resilience and the worst in economic ignorance.
Emotions run high during disasters, which is a double-edged sword.
The former includes individuals rescuing stranded neighbors, volunteers lining up to join charity relief efforts, and corporations martialing their vast resources to pour needed items such as food, bottled water and clothing into devastated areas. The latter includes “economists” repeating the age old broken window fallacy and politicians denouncing and threatening so-called “price gougers.”
Emotions run high during disasters, which is a double-edged sword. The outpouring of sympathy for the victims leads to extraordinary efforts in assistance. But it also leads to irrational resentment of those whose actions are often vital to human survival, but whose motives are judged inferior. These are, of course, the aforementioned price gougers.
One of the weaknesses in rational responses to the accusation of price gouging is just that: they appeal to reason when the accusation is born of emotion. And that disconnect is an irrevocable one until the accuser can be persuaded to look at the situation reasonably. But once so persuaded, the accuser often voices the understandable objection that economic arguments rooted in supply and demand charts and theory are too removed from what the accuser considers “the real world.”
Real World Behavior
Here, then, is a “real world” scenario in which the actors respond to incentives just as anyone in similar situations have countless times in the past:
There is a hurricane and flooding. Drinkable water is in short supply. A man has $100. He needs a case of water to get his family of three through the week. He walks into the store, where water is $25/case. There are 4 cases left on the shelf. He needs one, but can afford 4 and he doesn’t know how long the emergency will last. So, he buys all 4 cases.
All have made the best choices among the alternatives presented them.
Immediately afterwards, a family of five walks into the store with $100. There is no water to buy at any price. This family is now in desperate straits and must look elsewhere to procure what they need to survive.
Can anyone dispute the actors in this little parable have acted rationally and precisely as they would in the real world? No. Neither have any acted in a malicious or overly selfish manner. All have made the best choices among the alternatives presented them.
Now, change the price of a case of water in the above scenario to $100/case. What would be different? Of course, the man with a family of three would now only be able to buy one case of water, giving him what his family needs, but not necessarily as much insurance against future uncertainty as he would like. He gives up a little, but the family of five whose survival was in grave danger in the $25/case scenario is now able to purchase at least one case of water.
In the latter scenario, both families have enough to survive and a strong incentive to conserve water, thereby reducing demand and lowering its price, all other things being equal.
The so-called “price gougers” may have acted in their own interests, but they have not only benefited society economically, they have saved the lives of the family of five. Thus, Adam Smith’s 241-year-old “invisible hand” is confirmed by the real world yet again.
Incentivizing Other Entrepreneurs
But there are still those who claim that, while the price gougers have acted rationally and within their rights and may even have inadvertently benefited others, they have still acted immorally. In the case of the recent hurricane in Texas, many say,
“No, you don’t understand. Many of these people aren’t even from Houston. They knew the hurricane was coming and bought up a bunch of water at regular prices, with the express intent of coming to Houston and selling it for huge profits, while others were giving water away for free. That’s immoral!”
The so-called price gougers face all the same challenges as anyone else.
First, anyone selling water at any price is obviously serving people who don’t have access to the free water. If the buyers had access to free water, they wouldn’t pay for it, at inflated prices or not. Second, this sanctimonious moralizing begs the question, “Why didn’t you buy up a bunch of water and go to Houston and sell it at regular prices?”
The answers to the latter question are many, but they can be summarized as follows: most people do not have the time, capital or expertise to do what the price gougers did.
Who can afford to take off from their own job or cease running their own business to start a whole new one on a few days notice, much less donate their time? Some can, but not most, which is why after all those who can be by charitable work are served, there is still a market for those seeking profits.
We Need Price Gougers
Lost in all the moralizing is the reality that the so-called price gougers face all the same challenges as anyone else, having to forego whatever income they otherwise would have earned if not for their disaster-relief project, and face the risk of losing future income because they took off from their jobs or put their own regular businesses on hold. These losses and risks must be compensated, which is another reason they sell products at a premium price, in addition to supply/demand realities. There is a need for those seeking profits from higher-than-normal margins.
Thus, in the real world, even with as many people as are able acting as charitably as possible, there is a need for those seeking profits from higher-than-normal margins, whose self-interested actions save lives and mitigate the devastating effects of disasters. Yet, the rest of the world condemn them and governments seek to punish them, threatening not only the price gougers, but those whose lives they may save or whose suffering they may lessen during the next disaster.
Reprinted from Tom Mullen.