Many states have laws against "price gouging" during an emergency.

Are these laws counterproductive?

Take the current situation with toilet paper and water. When someone sees rolls of toilet paper on the shelf, they buy them all. Not because they necessarily need it, but out of fear the next person will buy them all and there won't be any left when they do need it. This creates a positively reinforcing feedback loop of negative cause-and-effect a/k/a/ a "vicious cycle."

But if prices spiked in response to meet demand, the feedback loop cycle would slow because two good things would happen that aren't happening now.

  1. Supply would increase. Increased prices signal suppliers (whose marginal costs remain constant) to manufacture and ship more product in order to maximize profit.

  2. Hoarding would mitigate. Hoarders would have less incentive to hoard supplies of water, toilet paper, etc. unnecessarily if they were paying significantly higher prices than normal. Then there would be adequate supply left for those who need it and aren't simply overstocking out of an abundance of caution. Moreover, would-be hoarders would feel like the next guy also has less incentive to hoard and thus quell their fear of being left with no supply when needed.

Is this a correct economic analysis or am I missing something that justifies "anti-price-gouging" laws?


Actually economics does not even officially use term price gouging. Your analysis is right, actually economists dislike anti-price gauging legislation for this reason.

For example, when the IGM panel of top policy economists were asked about one piece of price gouging legislation in the US, vast majority disagreed with it:

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However, an important caveat to keep in mind is that due to menu costs some firm would not be able to change prices quickly enough even in absence of anti-gouging regulation - meaning such regulation is not the sole source of shortages, there would be some even without them although less severe (and of course it goes without saying this is not any justification for them).

However, beside that yes, you are actually missing the main factor that justifies the anti-price-gouging legislation. Which is moral philosophy. There is argument to be made that such practices as gouging are immoral (you can see some ethical arguments against gouging in this paper for example). While I personally dont identify with such moral views, its not our role as economists to pass moral judgements. If people pass anti-gouging legislature well aware of all the negative economic consequences but they still do it despite them then there is no objection an economist can make against them as we are scientists not moral philosophers and such questions are beyond our discipline.

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There are no laws against "price gouging" where I live, at least the price of medical masks has increased 3-10 fold in the recent weeks, due to the coronavirus outbreak.

Yet there is still a shortage of masks. (Also several other things.) Why is this? You write that in the absence of price gouging laws

Supply would increase. Increased prices signal suppliers (whose marginal costs remain constant) to manufacture and ship more product in order to maximize profit.

And this is true in (a competitive market) in the long run. In the short run, stocks and production capacities are limited. In some cases imports can work, but in some cases (like right now) imports are not a good option.

A market equilibrium can still be achieved, even if supply does not increase at all, simply increasing prices high enough so that demand is reduced. Here fairness/ethical arguments - as explained by 1muflon1 - come into play. Most people accept that Hamilton tickets should go to the person who can and is willing to pay the most, but this certainty fades away in case of medical supplies. (Actual public opinion depends a lot on the exact phrasing of the question.)

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  • $\begingroup$ Two questions. First question. If mask prices are higher in your area (because of no anti-gouging laws) and lower in other areas (with anti-gouging laws) where do you think the resupply of masks is most likely to go first? The area with high prices? Or the area with low prices? Second question. Shouldn't at least one component of the ethical argument include what actually works in reality? And not just what makes us feel good about some abstract concept of "fairness?" Is it fair to artificially depress prices so the first person who arrives can buy out all the stock? $\endgroup$ – FreeMarketUnicorn Mar 17 at 13:12
  • $\begingroup$ @FreeMarketUnicorn Your first question is again a long run question. (By the way most neighboring countries with stocks and capacities forbade exporting the masks.) Your second question leads us to a philosophical debate. I do not wish to take a stand there, I was pointing out that market efficiency is not the only thing that matters. I will not respond to further comments, I do not wish to get into a prolonged back and forth. $\endgroup$ – Giskard Mar 17 at 13:39
  • $\begingroup$ Depending on the product and supply chain stock, resupply could happen same day or next day. That's short term. Not long term. Regardless, supply will likely flow first to where prices are highest. $\endgroup$ – FreeMarketUnicorn Mar 17 at 15:29

There is a behavioral literature that warns against `price gouging'. Two Nobel Prize winners, Richard Thaler and Daniel Kahneman, conducted surveys with Jack Knetsch. They report that 82% of survey respondents say that raising the price of a snow shovel when a snowstorm is approaching is unfair.

The reasoning is based on Thaler's concept of 'transaction utility' – the psychological pleasure or pain associated with how good of a deal a person associates with a transaction.

In the fairness framework, people have notions of reference transactions that they deem to be fair. Paying double for toilet paper generates the experience of negative transaction utility, if there is no corresponding increase in the marginal cost. In that framework, firms that charge double but do not incur higher costs are acting unfairly.

You may also listen to this great episode on Marketplace Economists don't think price gouging is a problem. But what about our social values?

Kahneman, D, J L Knetsch and R H Thaler (1986a), “Fairness and the Assumptions of Economics”, Journal of Business 59(4): S285-300.

Kahneman, D, J L Knetsch and R H Thaler (1986b) “Fairness as a Constraint on Profit Seeking: Entitlements in the Market”, American Economic Review 76(4): 728-41.

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  • $\begingroup$ How does Thaler address the problem of hoarders buying out all the stock when prices are artificially depressed? If someone voluntarily purchases a good at a higher price, doesn't the voluntary nature of that purchase mean the transactional utility is higher in that case than the alternative scenario of having no inventory to purchase because the price was artificially depressed and hoarders purchased all the stock? The consumer could have achieved the same result as the latter case by simply not buying at the higher price. But they voluntarily chose to pay the higher price instead. $\endgroup$ – FreeMarketUnicorn Mar 17 at 13:55
  • $\begingroup$ Good questions and I don't know how Thaler would approach this.Thaler would probably answer that the hoarders' behaviour is not fair and that consumers could retaliate afterwards (if the hoarders are clearly identified), as they did against Uber with the price spike. But this is just a guess. I just wanted to point out how behavioural economists see this problem. $\endgroup$ – emeryville Mar 17 at 14:30

As a first pass, it's helpful to think about the basic ideas of surplus, and I'm surprised that no one has discussed this aspect of the question yet. It is a basic fact, one that we learn in our intro to economics that the market-clearing price maximizes total surplus: consumers with the highest valuations for the product obtain it. Crucially, the mechanism through which the price effects this outcome is by

Separating high valuation customers from low valuation customers

However, there is a side effect:

Some of the total surplus is transferred from consumers to producers

Notably, this market clearing price does not generally maximize consumer surplus, and it is quite possible for consumer surplus to be maximized at a price below the market clearing price (the gains consumers get from the lower price outweigh the losses from mis-allocation).

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