There's Some Good in Gouging

Karen Selick is an attorney in Ontario, Canada, and a columnist for Canadian Lawyer

The great ice storm of January 1998 left millions of residents of Quebec and eastern Ontario in Canada (and in the northeastern United States) 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 one dollar a box, were marked up as high as four dollars, 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.

But Is It a Bad Thing?

The truth is, the sudden, dramatic 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 that 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. Proprietors 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 neighbors 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 the latecomers. Those who don’t already have a supply, and therefore need them 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 may 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 it will be to replace such goods 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 find themselves able to make a windfall profit on candles will do their utmost to get in a new supply. People outside the stricken region who hear about the huge profits to be made on candles will rush to the area with a stock.

This will further assist in making the shortage more bearable. As supplies flow into the area, competition among vendors will soon reduce candle prices to their former level—just as it did before the crisis began.

The Alternatives Are Even Worse

Price increases are simply one method of allocating scarce goods among competing users. It’s not perfect, but the alternatives are even worse. Suppose the government had passed a law making it illegal to sell candles at more than one dollar 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 favor. This would present an opportunity to curry favor with local politicians, bureaucrats, or other people of influence. A system that allocates goods by “pull” is surely no more fair than one that allocates goods by price. In normal times, we call this corruption.

Or suppose ration coupons had been issued for candles, so that everyone was entitled to buy an equal but restricted number at one dollar per box. This system would allocate candles to people who don’t really need them and deny an adequate supply to people who need them most urgently. 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 one-dollar candles while others use new four-dollar candles? Not really. Everyone knows that candles (or alternatives) are useful 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 decided to forgo some other commodity, or interest on their capital, 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.

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.