Economic fallacies persist for a variety of reasons. The most pernicious of these reasons - the one that guarantees the continued flourishing of such faulty thinking - is dissatisfaction with reality. On one hand, dissatisfaction with reality is, of course, the root of our motivations; the reason we better our situations and improve our lots. However, on the other hand, such dissatisfaction can lead people to believe in the impossible and in impossible ways to achieve their beliefs. As long as these inadequate believers are only fooling themselves this is not a problem. However, when such flawed believers hold the power to control and coerce others they can seriously harm those who must kowtow to their desires.
This dissatisfaction is always the motive when legislators attempt to countermand the fluctuations of a free market in an attempt to instill more "justice." Yesterday the Colorado House committee on Business and Labor passed a bill (hb 06-1251) that would prohibit the practice of "price gouging" during an emergency. True to the spirit of fallacious thinking, the bill carries with it a sense of self-evidence and moral righteousness - feelings of "how could this not be good?!?" and "how could this not work?!?" - that obscure its speciousness and fuel the ardor of proponents. The bill does serve, however, as an excellent object lesson in the poor economic thinking of lawmakers and their eagerness to consistently codify their ignorance and force the populace to bear the brunt of their uninformed meddling.
Advocating price ceilings has proven to be a ceaseless activity. In this situation the author of the bill has attempted to mollify his aspirations by only asking for a snippet of control - a fragment of legislated justice. As the language of the bill conveys, it is a law that would simply try to curtail unjust profits: not all profits, just those deemed to be "unconscionable." After all, as the reasoning goes, if the goods can be priced in such a way that allows everyone to have unfettered access to enough during normal situations why can't they behave similarly, with similar prices, during emergency situations?
Your feelings towards this type of legislation depend upon your answer to this question. You can either rely on the question's rhetorical nature, shrug a half-hearted "why not?" and continue about your day with your belief in price ceilings intact, or you can earnestly try to answer it. For those who behave in the former manner I have little hope that you have made it even this far into this essay; for those who behave in the latter I will give you the answer right here: the price cannot remain the same in an emergency situation because every single factor that contributes to the determination of a market price has changed. To attempt to control the price is to do nothing different than to pretend these factors haven't changed. It is the "fingers-in-the-ears-while-chanting-la-la-la-I'm-not-listening" approach to reality.
A disaster situation can destroy supply and create new demands that previously were not a part of the economy. It can change the entire nature of the game in a nano-second and leave everyone on their heels. If there existed a system of information transmission that could immediately account for the new realities of supply and demand and convey those realities to those in need quickly then these situations wouldn't pose an insurmountable problem. Such a system and its ability to constantly update with regard to relevant information would seem magical in the way it pulled together massive amounts of disparate information about supply and demand and communicated it to those in need. Thankfully this magical system exists in the form of freely fluctuating prices.
A price is simply a method of conveying information - information about how much is available and how much is desired - to the people. When left to freely fluctuate it will perform this task better than any human, group of humans or even massive collection of supercomputers ever could. Furthermore, a profit and a price exist in an inexorable relationship. A profit (possibly not monetary - i.e. giving away something that is taking up space - but usually monetary) represents the only incentive for the seller to engage in a transaction.
What always lies behind any use of the term "price gouging" is the incorrect belief that there is something special, just, and right about a price at a given time - usually the time when consumers could purchase as much as they wanted and have little concern for the cost. If you happen to hold this belief dispelling it from your head is an essential first step towards achieving even the most moderate level of economic literacy. It is precisely because there is no "right" price that the pricing system has any meaning and is able to function at all. Because of this fact you will almost never hear an economist seriously use the term "price gouging" except in refutation.
It would behoove you to ask yourself which of the following situations is an example of "price gouging:
- Selling a baseball card purchased for $2 for $1000
- A bar that sells a martini for $10 ten miles from a bar that sells the exact same martini for $5
- The rent of an apartment in the city increasing $200 in five years
The answer; none of them. Numerous factors will cause prices to fluctuate. This is the point of a price and, ultimately, why the system works at all. We must also remember that coupled with the right to make a profit is the right to take a loss. The two are inexorably intertwined.
During a transaction a seller wants to sell at the highest price and a buyer wants to buy at the lowest price. What happens when the price is legally mandated to be below the confluence of these two desires; i.e. the market price? Simple, the seller sells what he has and then packs up and goes home. Due to the artificially low price the buyers are left wanting more. Whenever a buyer and seller disagree on quantity to be sold the lowest desired quantity always wins - because they can pack up and go home. The buyers are left unfulfilled in their demands as the seller's doors are locked tight.
A line forms.
In an emergency situation, when basic rational decision making will be countermanded by fear, a line will most certainly form. It must be realized that this line increases the real cost of the good. If one can only acquire a good by idly standing in a line for hours this lost time most certainly represents a cost to the consumer. This time-cost must be added to the monetary cost that will be paid once the good is acquired. In an emergency situation what will be lost in this idle time is time for preparation (i.e. nailing boards on windows, moving belongings to higher ground, etc) that may save lives and property. Many may not be willing to pay this time-cost and simply go without the goods. However, it must be remembered that a new, albeit more complex, price emerges that must be paid to acquire the goods.
The ultimate distribution of the goods becomes dependent on a number of factors, most of which have little to do with money; position in line, number of members in the family who can trade-off on line-standing, etc. Of course, without other rules applied the entire situation may end before it begins. Without a "limit one per customer" rule when the seller's doors open the first person will simply buy an exorbitant amount of the product; a product which now, with the buyer's increased, in-the-face-of-danger demand and the artificially maintained price, seems like the bargain of the century. This situation is not like the recent rush for Xbox 360s. In an emergency situation the majority of "life and death products" do not satisfy demand with a single unit. The demand becomes ravenous and an excess is seen as desirable. The seller may try a "limit only what you absolutely, truly, cross-your-heart-and-hope-to-die need" rule but I doubt it will do any good.
Meanwhile, the guy who got to the head of the line and bought a large amount of bottled water at a ridiculously low price is out in the street selling the product at three times what he paid for it (price gouging?). Others may wish to overcome the time-cost by simply offering more money to the supplier - money above the legally mandated price; a twenty slipped across the table. Or, they may use their money to pay another to stand in the line. A system of illicit transactions will emerge; otherwise known as a black market. All of this happens even when an emergency isn't pressing upon the will of the populace and bringing the pot to a boil. During an emergency the stakes become even higher. In one way or another - with time, money, criminal acts, etc. - people will pay the increased price to obtain the goods.
Hmm...I wonder if there is a simpler way to avoid all these boondoggles?
For all intents and purposes nothing is ever sold with zero profit. The profit represents the only incentive for the seller to engage in the transaction in the first place. The only way to reasonably encourage a seller to engage in a higher number of transactions than are normally called for, as during an emergency, is a corollary increase in profit. When the profit is increased the seller will be willing to stay open longer, provide more efficient store functioning, maybe drive a couple hundred miles to pick up stock, in addition to a variety of other actions that will increase the seller's ability to sell the goods. The high price, that is the high profit, will serve as the incentive for sellers and distributors to move as much of the desired commodity to the affected area as fast as possible. After all, if they don't they are going to miss out on the profits. Such incentive cannot be legislated or pulled from thin air. Furthermore relying on "man's goodwill to man" in a time of heightened self-interest will be equally inadequate. And, as the tragedy surrounding hurricane Katrina demonstrated, governments - working solely from governmental incentives - are inadequate at delivering required relief during emergency situations.
Of course, in an emergency situation, the increased profit generally comes from an increased demand. It is a demand, as has been pointed out, that could be ravenous and irrational. However, the increased price will serve to rationalize, even if only slightly, irrational demand. The buyer will ask himself if buying ten cases of bottled water and thirty-five first aid kits makes complete sense. In doing so the goods, whose distribution to the needy is so paramount, will be automatically rationed. People will be forced to readdress what they "need" in light of what they can get. When essential goods are in short supply one cannot count on people to ask themselves, due to sheer good will, if they really "need" that second bottle of water when, perhaps, they should go a little thirsty so their neighbor can have a drink.
Hotels in disaster areas may triple or more in price. This represents the change in supply (housing destroyed) and the change in demand (willing to stay anywhere with a roof). The price change, however, will force rationing of those very essential goods. Families will rent one room for all when they may have previously rented three at a lower price. Others may decide to stay at a relative's rather than a hotel. The owner of the hotel will charge what the market will allow; just as he did when everything was "normal."
In other words, it is just as justified to describe pricing under "normal" economic conditions as "price gouging" as it is to do so under emergency economic situations. The seller will always attempt to charge what the market will allow. You have an orange. Someone offers you $2 for it. Another comes along and offers you $3. Under the ideological commitments of anti-price-gougers if you do not take the $2 bid (or some other price that is randomly pulled out of the air and deemed "just") you are "unconscionable" and possibly liable to criminal prosecution. Such laws do little more than criminalize rationality.
Disasters are unfortunate situations in which reality has made total satisfaction of all needs difficult. Because disasters produce new situations the price cannot remain the same. Wishing that everyone in a disaster area had a place to stay and fresh water to drink doesn't change the simple truth that these things have become hard to come by. But, an abundance cannot be legislated into existence. Somehow what goods are there must be distributed. Therefore, a distribution system must be chosen from alternatives. Unfortunately, a magical distribution system that executes perfect justice is not one of those options. Price-ceilings and government control are an option but, as I have shown, are totally inadequate. A free-fluctuating price system is the only viable option to create a rational (even if it is not perfect) distribution.
Of course the quickest objection to this idea is that it will be a distribution based on wealth, not need. However, in a situation where demand exceeds supply due to price control a higher price will emerge (lines, black market, etc.) that must be paid to acquire the goods. This is exceedingly true in a situation with emotionally-driven fervor. In this situation a distribution of goods will result that is based on criteria other than wealth; criteria that are equally unrepresentative of need: i.e. how far you live from the seller, how many people you know to stand in line, whether you're friends with a store-owner, or just pure and simple luck. Would you rather goods be distributed on the basis of these random inequalities? However, what will not emerge is an increased supply of the goods. More people will go without. If the seller's incentives cannot rise with the buyer's then someone's demands will not be met. In an emergency situation this lack of goods will have dire consequences.
It is incontrovertibly true that such legislation as the Colorado "price gouging" bill cannot and will not work. Although you would be hard-pressed to find an economist in the world who believes this to be a good idea you will not be equally hard-pressed to find legislators who are willing to ignorantly cast a "yea" vote. This, of course, is the unfortunate problem.