Quiz for Thursday 28 January

Florida has a law that forbids "price gouging" after natural disasters, i.e. it is illegal to ask for a price for essentials such as plywood, ice, bottled water, small generators, plastic roof sheeting, etc in excess of the normal price in the immediate wake of, e.g., a hurricane. Two questions:

  1. From an efficiency point of view, why do most economists argue this law is a bad idea?

    2.  

     

    A good answer would hit two points: (1) by preventing the price rising, the law will prevent entrepreneurs who might be attracted by the possibility of high prices [and therefore economic profits] to bring in the needed goods from outside the disaster area [after a recent hurricane in South Florida, there was a press report of two brothers from Atlanta selling portable electric generators by the side of the road out of a truck they had driven down]; and (2) by preventing the price rising, goods that are available do not necessarily go to those who value them highest, and some other principle or mechanism (e.g. queuing in the hot sun) has to be used to determine who does get the goods that are available.

  2. In that case, why do you suppose it exists?
Economics, and especially public policy, is not only about efficiency [jargon word], but also about equity [another jargon word; in economics, fairness, not how much of the value of your house or car you own]. Many people consider it unfair that, after a disaster, (a) some people [like the brothers from Atlanta] should profit from other people's misfortune, and (b) those who happen to be wealthier should be able to get necessities and conveniences that others in just as bad or worse shape because of the disaster cannot afford at the new, higher, short-run equilibrium price that would rule for a short period immediately after the disaster.

OK answers would note for 1) that this policy prevents the market working, and for 2) that people see it as unfair to allow the price to rise to the market-clearing level.

Note that the policy [if enforced] will make certain that in the immediate aftermath of the disaster that there will be physical shortages [excess demand] for some goods, because demand has been shifted out by the disaster but supply will take time to respond. So there will be lines, black markets, rationing of purchasers to only small amounts, and stores running out. By stopping the price rising and additional suppliers (like the brothers from Atlanta) responding, you guarantee for a short period of time that there will be people who cannot get the quantity they want to buy, at a price they would be willing to pay. This is inefficient; but many people evidently consider it fair, because it "shares the pain" and prevents individuals profiting from others' misfortune. Before very long, supply does respond and adequate quantities of the goods in question flow in to the disaster area by means of normal distribution channels and special actions by relief agencies -- so prices would revert to normal within a few days to weeks anyway.