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Wednesday, November 28, 2012

Hurricane Sandy’s Lesson on Preserving Capitalism

I thought I'd note this column from several weeks ago for two reasons. First, it was widely misinterpreted as supporting laws against price-gouging, but I didn't mean to disavow the price-system. The point was that there is a lesson in the public's reaction to price-gouging: When the public believes the price-allocation mechanism results in unfairness, they won't support it. Market fundamentalists, and those who support capitalism more generally, should worry more than they do about how increasing inequality or the increasing market and political power of those at the top will affect the public's perception of the fairness of the capitalist system. If the belief that the system is unfair crosses the tipping point, who knows what type of system could be adopted in its place. Second, and more to the point, I haven't had much luck finding things to post today, and no time to write something myself (so this is filler):

Hurricane Sandy’s Lesson on Preserving Capitalism: With long gas lines and other shortages putting people on edge in the wake of Hurricane Sandy, the usual post-disaster debate over the economics and ethics of price-gouging is underway. However, while the question of whether it is okay, even desirable, for businesses to raise prices after natural disasters is certainly important, there are larger lessons that can be drawn from this debate.
Economists do not like the term “price-gouging.” They believe that price increases are the best way to allocate scarce goods and services after a natural disaster and, importantly, to encourage additional supply. When people can make a large profit by supplying goods and services to a market, they will work extraordinarily hard to meet the demand.
But if there is such an advantage to allowing the price system to work after an event like Hurricane Sandy, why did producers often choose to stick with pre-disaster prices? Why would they leave profits on the table by maintaining pre-disaster prices and allocating goods through other mechanisms such as first-come, first-serve until supplies run out? One answer is that price-gouging after a natural disaster is illegal in many places. But this just begs the question. Why do so many places choose to prohibit large price increases in response to disaster induced shortages?
Most of the explanations economists have come up with rely upon the idea of fairness. ...[continue]...

Let me add one reference to a study by Daniel Kahneman I didn't know about when I wrote this supporting the notion that perceptions of unfairness undermine support for the price-allocation system:

As far as most economists are concerned, it would be totally reasonable for a grocery store to raise prices the day be for a hurricane. In fact, that's what's supposed to happen. If prices don't go up when demand increases, you wind up with shortages. To an economist, empty shelves at grocery stores are evidence that prices were too low.

In a famous study, the Nobel laureate Daniel Kahneman and his co-authors asked ordinary people lots of questions about pricing and fairness. In one question, a hardware store raised the price of snow shovels from $15 to $20 the morning after a snowstorm.

The higher price sends a signal to the world that says: Send more snow shovels! Someone who runs a hardware store an hour away might be inspired by to put a bunch of shovels in the back of a truck and bring them to town, easing a potential shortage and, perhaps, driving prices back down.

But, not surprisingly, eighty percent of people surveyed said raising the price of snow shovels after a storm would be unfair. Presumably, those people would also say it's unfair for a store to double prices on canned food the day before a hurricane.

People feel so strongly about this that they've passed price-gouging laws in many states, banning merchants from raising prices during hurricanes or other natural disasters.

    Posted by on Wednesday, November 28, 2012 at 10:29 AM in Economics, Regulation | Permalink  Comments (27)


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