Economists Are Wrong About Price Gouging
5 min read
Last week, the economics commentariat and much of the mainstream media erupted with contempt toward Kamala Harris’s proposed federal price-gouging law. Op-eds, social-media posts, and straight news reports mocked Harris for economically illiterate pandering and warned of Soviet-style “price controls” that would lead to shortages and runaway inflation.
The strange thing about these complaints is that what Harris actually proposed was neither radical nor new—and it certainly wasn’t price controls. In fact, almost every state already has a law restricting at least some forms of price gouging. Although Harris has not specified the exact design of her proposal, one hopes that it would follow the basic outline of state-level bans: forbidding unwarranted price hikes for necessary goods during emergencies.
Price gouging in the popular imagination has a “know it when you see it” quality, but it is actually a well-developed body of law. A typical price-gouging claim has four elements. First, a triggering event, sometimes called an “abnormal market disruption,” such as a natural disaster or power outage, must have occurred. Second, in most states, the claim must concern essential goods and services. (No one cares if you overcharge for Louis Vuitton handbags during a hurricane.) Third, a price increase must be “excessive” or “unconscionable,” which most states define as exceeding a certain percentage, typically 10 to 25 percent. Finally, the elevated price must be in excess of the seller’s increased cost. This is crucial: Even during emergencies, sellers are allowed to maintain their existing profit margins. They just can’t increase those margins excessively.
For example, early in the coronavirus pandemic, some New York City residents complained that grocery stores were charging exorbitant prices for Lysol. But because those stores were merely passing along price increases from their distributor, they didn’t get in trouble. Instead, the state pursued a case against the wholesaler, which agreed last year to pay $100,000 in penalties and restitution. (During the pandemic, I took a sabbatical from teaching law to work for New York Attorney General Letitia James, with a focus on price gouging; I worked on the appeal of the Lysol case.)
Price-gouging bans are broadly popular—except among economists. The reason is that, in the perfect world of simple economic models, allowing sellers to charge whatever they want during periods of heightened demand is actually a good thing: It signals to the rest of the market that there’s money to be made on the product in question, which in turn leads to more supply. Accordingly, prohibiting gouging leads to less production of essential goods and services. Plus, letting prices rise helps ensure that the product will be sold to the people who value it the most.
Here, regular people seem to understand a few things that economists don’t. During an emergency, such as a natural disaster, short-term demand cannot be met by short-term supply, setting the stage for sellers to exploit their position by raising prices on goods already in their inventory. The idealized law of supply and demand predicts that new investors would rush in, but the real world doesn’t work like that. A short-term price spike won’t always trigger the long-term investments needed to increase supply, because everyone knows that the situation is, by definition, abnormal; they can’t count on a continued revenue boom. During a rare blizzard, sellers might jack up the prices of snowblowers. But investors aren’t going to set up a new snowblower-manufacturing hub based on a blizzard, because by the time they had any inventory to sell, the snow would long be melted. So after the disruption, all goes back to normal—except with a big wealth transfer from the public to the company that raised prices.
And that’s before taking into account the barriers to entry that exist in today’s concentrated markets. Incumbents in heavily consolidated sectors like food are largely insulated from the threat of new competition. Price-gouging laws thus operate as a kind of poor man’s antitrust. They don’t address the lopsided balance of power, but they at least prohibit that power from being exploited in certain high-stakes contexts.
The other big problem with the textbook economics take on price gouging is the assumption that temporarily higher-priced products will find their way to the people who value them the most. That might be true in a world where everyone had the same amount of money to spend. In the world we actually inhabit, that is not the case. During a power outage, a working-class cancer patient who desperately needs to buy the last generator in stock to keep his medications refrigerated might not be able to outbid a healthy millionaire who just wants to run their air conditioner.
This is another way of saying that price-gouging bans are a form of moral policy. The laws recognize that consumers, not being the coldly rational Homo economicus of academic models, are going to be less price-sensitive during disaster; their desperation can be exploited. And people who lack the savings to get through a crisis or the resources to comparison shop are even more likely to suffer from price increases on essential items. In a pandemic, war, or major weather event, it seems morally repugnant to give an unearned bonanza to a big firm while denying essential services to vulnerable members of society. All parents, not just the wealthiest, should have an equal chance to obtain diapers even if supply chains are disrupted. Price-gouging laws represent a different set of market rules, grounded in fairness.
Price-gouging laws also protect against volatility and instability. During the immediate aftermath of COVID, unchecked price increases made an already-bad inflation problem even worse, contributing to a dangerous spiral that harmed the macro economy as well as individual consumers.
The problem with price-gouging laws is that they exist only at the state level. Few states have the resources to take on the multinational corporations that dominate markets for many essential goods. Even if they did, they would still face jurisdictional challenges. If a company makes baby formula in Wisconsin and then sells to a distributor in Minnesota, which then sells to a supermarket in Oregon, that company might radically hike the price it charges in Minnesota when the next pandemic hits—but then be unreachable by the Oregon attorney general even if Oregonians end up paying the cost.
Most price gouging today happens far beyond the reach of most state attorneys general. A strong federal law would help not only the public but also the small-business owners who lack the ability to do anything but pass on big increases—and who become, unfairly, the face of ugly profiteering for many consumers. If properly designed, such a law would very rarely need to be used. With a federal ban in place, the biggest corporations in the world would keep a price-gouging expert at the ready to wag their finger the next time they’re tempted to exploit a disaster for profit.
