Price gouging – definition and examples

Price gouging is a situation where business take advantage of an external crisis to charge excessive prices for basic necessities – selling the goods significantly above their usual price.

Many countries have laws against the practise of price gouging – to protect consumers against unfairly high prices during a national emergency.

Example of price gouging

A recent example of price gouging is individuals who have been stock-piling hand-sanitiser and face masks to sell for inflated prices during the Coronavirus. For example, two brothers in the US bought nearly 18,000 bottles of hand sanitizer at around $1 from stores in Tennessee and Kentucky and were seeking to resell for between $7 and $70. Matt Collin who stockpiled the hand-sanitiser said:

“I saw a demand, that’s what I have to say about that,”

They sold 300 bottles around the country before their online store was shut down and they were investigated for price gouging.

Economics of price gouging

During national disasters such as earthquakes, hurricanes or widespread disease, we can see an unexpected surge in demand for certain products. The disaster may also cause a fall in supply. Therefore, for basic necessities, the market equilibrium may jump – several hundred percent.

• After the hurricane, there may be a surge in demand for electric saws to chop down trees or demand for temporary tents.
• After an earthquake, there may be a surge in demand for food or clean water.
• The outbreak of Coronavirus has led to a surge in demand for face masks, hand sanitisers and ventilators.
• A feature of price gouging is that some firms and individuals who are able to get hold of scarce supplies gain a temporary monopoly power for selling that product. Because demand is very price inelastic, the firms with the supplies could in theory charge very high prices.

What is price gouging?

• If a national emergency is declared, then if a firm sells the product above average prices for the last 30 days, then it is counted as price gouging. Some states may allow a 10% increase above past average prices.
• If supply is disrupted and the cost of selling the good rises, then passing the cost increase onto consumers does not count as price gouging. For example, if foreign imports of food are disrupted and domestic food is more expensive, a proportionate increase in prices would not be counted as price gouging.
• In the UK, price gouging is regulated under the Competition Act 1998, which lists price gouging as an unfair business practise.
• There can be an element of uncertainty over some price increases, e.g. is price increase due to disruption in supply or is it due to abuse of monopoly position?

Should price gouging be legal or illegal?

Not all economists believe price gouging should be illegal. Libertarian economists, such as Thomas Sowell and Walter E. Williams have argued price gouging serves a useful purpose for allocating resources during a disaster.

Arguments for price gouging

• Encourage stockpiling. The prospect of charging high prices for scarce resources may encourage firms to stockpile for emergencies. Then when an emergency strikes, there are more of the basic necessities available. If firms are not allowed to charge higher prices during an emergency, there is no incentive to stockpile for emergencies.
• Ration demand to those who need most. High prices may ration demand to those who want it most. If the price of chainsaws surges after a hurricane, it will mean that only those who desperately need it will buy – those who only need it for moderate needs, will wait. It can be self-selecting.
• Incentive to increase supply. Price gouging may provide an incentive for a company to invest in increasing production or incurring transport costs and deliver the needed material to the areas in need. If prices have to stay at the average, firms may make a loss in selling basic necessities to areas of most need.
• Allocatively inefficient. Price gouging legislation prevents firms charging a price according to consumer preferences. If the price of face masks are kept low, people who don’t really need it may buy.

Arguments against price gouging

• Price gouging can lead to inefficient displacement activity. For example, if individuals buy up stocks from shops and resell them, they are spending time and effort to distribute the goods at a higher price, but they are not increasing the number of scarce resources. Consumers may also have to spend more time finding where to buy the goods. Rather than buy from the supermarket, they have to find the resellers, which is costly in time.
• Ability to pay does not equal need. Price gouging can put basic necessities out of the reach of poor people who desperately need them. If prices are very high, they those with savings and high income can buy – even if they don’t really ned. But, those who are most vulnerable may not be able to afford. This creates an inefficient allocation of resources as those who need it most, are not able to afford.
• Libertarian economics breaks down the social contract. In times of emergency, it is vital that people feel ‘we are all in it together’ and there is some kind of social contract. Price gouging creates an atmosphere that it is the ‘survival of the fittest.’ This can make it difficult to maintain social order and prevent panic-buying and hoarding. Strict legislation against price gouging will deter people from more anti-social practises.
• Altruism. Libertarian economists assume that the profit motive is the main motivator of human behaviour. But, actually, concepts of fairness are very important – especially in an emergency. Making a profit from people’s fears and medical needs feels unfair to many people. At the very least, firms would gain very bad PR from charging excessive prices. There is strong peer pressure against hoarding and price gouging.
• Government intervention. In times of crisis, there is a good case for government intervention to deal with shortages through central buying and then distributing according to need. For example, war-time rationing and the government requisitioning face masks and allowing hospitals and medical staff to share out on who needs most.
• Hard to predict. Nobody could have predicted the shortage of hand-sanitisers, facemasks and ventilators in early 2020. So the ability to price gouge would not make any difference to stock-piling.

Conclusion

There are very good reasons to have legislation against price gouging. Economic arguments about efficiency are outweighed by more important concepts of fairness, and equality of outcome. Free-market economists argue that price gouging can encourage more stock-piling.

Related

• Pros and cons of capitalism
• Criticism of Free Market Economics