Economists are people who specialize in studying how this all works. But the truly great economists have always understood that markets, despite their huge value, have limits. Smith teaches us that culture and morality are as important as supply and demand in helping us understand how economies work. Imagine that you operate a motel on I, somewhere between Dallas and Houston.
Your place is okay, but just barely—the carpet is worn, the swimming pool is cloudy, and the air conditioning makes too much noise. Now Houston floods and many desperate people are at your front desk. You acquired the motel through legitimate means. There are no negative externalities at play. The exchange is, by definition, mutually beneficial. You might believe that your own self-interest is all that matters and so you act in a way that achieves your immediate pecuniary goals. You care about more than yourself and your kinship group.
So, as you stand behind the front desk thinking about the masses outside the door clamoring to be let in, you worry a lot about who in that group is most in need. You might, for the noblest and most enlightened reasons, sell only to the highest bidders.
You know that assigning a room to one family means turning another family away. And when every family is desperate, who is most desperate? Remember, too, that lots of people are going to need all kinds of help. Suppose, for example, that someone in the mob out front has relatives with a spare room in Dallas but needs gas money to get there. Why not generate extra cash and then give them some of the money?
Consider, for example, the practical problems of running your motel. To begin with, you have to figure out the correct price. You know that fact because you have years of experience managing a motel, not because the Market Fairy drew a supply and demand curve in the clouds.
Typically, the people who most value the product are also those willing to pay the most: under price-based rationing, they will be the purchasers.
People working in care homes on a minimum wage may need hand sanitisers more than office workers working from home, but they are likely to be less able to pay an extortionate price. In such a situation, price-based rationing will not be the best way to ensure that products go to the people who value them most. It may also harm the least well off.
For example, providing hand sanitisers to essential workers may help to slow transmission of the virus and provide positive benefits for wider society. To the extent that higher prices are driven by such factors, this will tend to harm society. It may also have implications for inequalities between people. Products will be bought by those who are most cautious or worried, those most able to search for supplies or those most able to afford to stock up. Products may not necessarily be bought by those who value them the most.
Now consider the supply side : Sharp increases in price may not be necessary to encourage firms to increase the amount they supply, or to enter a market. First, there may be limited flexibility to increase short-run supply in response to a short-run price rise. Second, even where there is such flexibility, high current prices do not need to be excessively high to signal an immediate supply-demand imbalance.
Indeed, where information on the imbalance between supply and demand is easily available, this may be sufficient to encourage firms to expand supply without any need for a large increase in prices. Where prices are driven up further by strategic hoarding, prices do not reflect true demand and supply.
There is a risk that inflated prices may encourage illegal activity, in the form of either the supply of fraudulent products or theft of products that are in short supply. What should be done about it? In the context of emergencies, there may be merit in limiting price rises. Create substantial uncertainty for firms about what prices are allowed in the absence of a well-defined price cap.
This might occur especially if the costs facing firms are also changing, thereby creating a legal risk that the firms might inadvertently breach the rules. Damage incentives to innovate and invest if the regulated prices are set too low. In the current emergency, regulation that limited price increases could mean, for example, that suppliers are less willing to incur the costs of repackaging and the logistics required to move stocks between distribution chains to reflect the shift in consumer needs.
Lead to supplies of products that can be sold in international markets being re-channelled towards countries with higher prices. To give legal certainty to firms, and also to allow speedy and low-cost enforcement, the test for price gouging would need to be relatively clear-cut.
Fortunately, given the specific, and short-term, nature of emergency price gouging, this may be more straightforward than when assessing longer-term excessive pricing. The fact that any rules would apply only over the short term will limit the risk of reduced incentives for long-run investment and innovation.
Allowing firms to put forward a cost-based justification for their price rises would also help to reduce the risk to short -term investment: it should give firms confidence to incur additional costs where this is necessary to expand supply. Finally, limiting the scope of the prohibition in particular to essential products would allow it to be targeted at the most serious areas of concern, while creating minimal legal uncertainty and distortions to incentives beyond this.
What next? What else do we need to know? The CMA is developing research work in this area. To offset this loss, retailers might raise the prices of essential items in an effort to stay in business.
On the other hand, when the demand for essential items or services suddenly increases, the supply can quickly become very limited, further increasing prices. To help limit the spread of the virus, governments are urging people to practice social distancing and self-isolation.
An unintended consequence is a shortage of essential supplies—like hand sanitizer and disinfectants—due to the rush of people preparing to stay home for the foreseeable future. As a result, there have been reports of price gouging for such items.
The phenomenon is not new or uncommon. Stories of price gouging in Florida after Hurricane Matthew made headlines in when prices for gas, hotels, water, and other essentials skyrocketed during a declared state of emergency. The same issue arose in Texas following Hurricane Harvey in When demand reaches such high levels, it can be hard to tell the difference between supply and demand and price gouging.
Policymakers and business professionals have historically had mixed opinions on whether businesses should raise prices during a crisis for this reason. Price increases due to natural disasters are a classic example of price gouging, and the government will usually intervene and directly prevent companies from doing so. But there can be unintended consequences to such market interventions, which explains the ongoing debate among economists and policymakers regarding the proper response to natural disasters and price gouging.
For business owners, deciding how to adjust prices during a time of crisis is both a practical and moral question. In many cases, raising prices on high-demand items can help offset the loss of revenue from low-demand ones and keep a company in business. At the same time, business owners are morally obligated to provide customers fair access to essential items in times of need. There will always be those who try to intentionally benefit from these kinds of scenarios.
Many economists argue that taking advantage of a boom in demand is a reasonable aspect of a market-based economy. But professionals often find themselves walking the line between raising prices enough to stay in business and remaining fair to their customers.
The answers to these questions are hardly ever straightforward. To further complicate the issue, many anti-price gouging state laws provide only vague guidelines for businesses, making it even more difficult to decide where the difference between supply and demand and price gouging lies.
In the United States, 24 state governments and Washington, D.
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