Re: Free Market Works

[SheetWise]

Hurricane Katrina has prompted legislators in the Gulf region to again threaten prosecution for any violation of anti-gouging laws. It reminded me of a good article by Thomas Sowell last year.

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'Price gouging' in Florida
Thomas Sowell


In the wake of the hurricanes in Florida, the state's attorney general has received thousands of complaints of "price gouging" by stores, hotels, and others charging far higher prices than usual during this emergency.


"Price gouging" is one of those emotionally powerful but economically meaningless expressions that most economists pay no attention to, because it seems too confused to bother with. But a distinguished economist named Joseph Schumpeter once pointed out that it is a mistake to dismiss some ideas as too silly to discuss, because that only allows fallacies to flourish -- and their consequences can be very serious.


Charges of "price gouging" usually arise when prices are significantly higher than what people have been used to. Florida's laws in fact make it illegal to charge much more during an emergency than the average price over some previous 30-day period.


This raises questions that go to the heart of economics: What are prices for? What role do they play in the economy?


Prices are not just arbitrary numbers plucked out of the air. Nor are the price levels that you happen to be used to any more special or "fair" than other prices that are higher or lower.


What do prices do? They not only allow sellers to recover their costs, they force buyers to restrict how much they demand. More generally, prices cause goods and the resources that produce goods to flow in one direction through the economy rather than in a different direction.


How do "price gouging" and laws against it fit into this?


When either supply or demand changes, prices change. When the law prevents this, as with Florida's anti-price-gouging laws, that reduces the flow of resources to where they would be most in demand. At the same time, price control reduces the need for the consumer to limit his demands on existing goods and resources.


None of this is peculiar to Florida. For centuries, in countries around the world, laws limiting how high prices are allowed to go has led to consumers demanding more than was being supplied, while suppliers supplied less. Thus rent control has consistently led to housing shortages and price controls on food have led to hunger and even starvation.


Among the complaints in Florida is that hotels have raised their prices. One hotel whose rooms normally cost $40 a night now charged $109 a night and another hotel whose rooms likewise normally cost $40 a night now charged $160 a night.


Those who are long on indignation and short on economics may say that these hotels were now "charging all that the traffic will bear." But they were probably charging all that the traffic would bear when such hotels were charging $40 a night.


The real question is: Why will the traffic bear more now? Obviously because supply and demand have both changed. Since both homes and hotels have been damaged or destroyed by the hurricanes, there are now more people seeking more rooms from fewer hotels.


What if prices were frozen where they were before all this happened?


Those who got to the hotel first would fill up the rooms and those who got there later would be out of luck -- and perhaps out of doors or out of the community. At higher prices, a family that might have rented one room for the parents and another for the children will now double up in just one room because of the "exorbitant" prices. That leaves another room for someone else.


Someone whose home was damaged, but not destroyed, may decide to stay home and make do in less than ideal conditions, rather than pay the higher prices at the local hotel. That too will leave another room for someone whose home was damaged worse or destroyed.


In short, the new prices make as much economic sense under the new conditions as the old prices made under the old conditions.


It is essentially the same story when stores are selling ice, plywood, gasoline, or other things for prices that reflect today's supply and demand, rather than yesterday's supply and demand. Price controls will not cause new supplies to be rushed in nearly as fast as higher prices will.


None of this is rocket science. But Justice Oliver Wendell Holmes said, "we need education in the obvious more than investigation of the obscure."


September 14, 2004

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[sam h]

The premise of this article is stupid. The point about price controls in general is that they shift the supply curve because supply is elastic - you're talking about a long period of time and the assumption is that suppliers are capable of adapting their production of goods. In a short term situation, supply will never shift like this. Nobody is building a hotel in a couple days. So its not a question of anti-gouging laws being inefficient. Its just a question of whether you are going to allow producers to gather the full rent from a short-term disjunction of supply and demand. He tries to cover this up with these dumb anecdotes about demand changing, but that is basically beside the point. Isn't this guy supposed to be an economist?

[SheetWise]

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The premise of this article is stupid ... In a short term situation, supply will never shift like this... He tries to cover this up with these dumb anecdotes about demand changing, but that is basically beside the point.

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I see. Your analysis completely excludes demand from the equation. His inclusion of demand you find to be "dumb anecdotes" and "beside the point".

Yes he is an economist.

[sam h]

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I see. Your analysis completely excludes demand from the equation. His inclusion of demand you find to be "dumb anecdotes" and "beside the point".

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Pretty much. Because the point about economic efficiency and price controls rests completely on the supply side. Controls shifting the demand curve in the short term has nothing to do with efficiency. In addition , the points he makes about demand - that large families will get fewer rooms and that people with decent enough houses wont get rooms - are totally speculative and probably represent very minor effects anyway.

[SheetWise]

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Pretty much. Because the point about economic efficiency and price controls rests completely on the supply side. Controls shifting the demand curve in the short term has nothing to do with efficiency.

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Who's defining efficiency?

Earlier you said -

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Its just a question of whether you are going to allow producers to gather the full rent from a short-term disjunction of supply and demand.

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I'm curious -- do you believe producers should be able to gather the full rent from a long term disjunction?

You also stated -

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In a short term situation, supply will never shift like this.

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It's amazing how quickly supply can change -- if you allow prices to change.

Unlike some -- I don't believe the supply chain is stocked because people are benevolent.

[sam h]

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Who's defining efficiency?

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I was refering to the degree that resources are being used in the most productive fashion possible. In this case, price controls only affect efficiency if supply can shift.

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I'm curious -- do you believe producers should be able to gather the full rent from a long term disjunction?

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In an abstract market system, a long term disjunction is theoretically not possible since supply will just adjust to the increased demand. Of course, it doesn't always work this way in the real world. I generally do not support price controls, but believe that other forms of intervention that can help foster competition are often necessary.

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It's amazing how quickly supply can change -- if you allow prices to change. Unlike some -- I don't believe the supply chain is stocked because people are benevolent.

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It depends on the sector. Nobody is building a hotel in a week to take advantage of a hurricane. Obviously supply does not depend upon benevolence. What does that have to do with anything?

[tylerdurden]

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In an abstract market system, a long term disjunction is theoretically not possible since supply will just adjust to the increased demand.

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That assumes that prices are not held artifically low. If there are price caps, supply will decrease, not increase.

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Of course, it doesn't always work this way in the real world. I generally do not support price controls, but believe that other forms of intervention that can help foster competition are often necessary.

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Such as? And when *would* you support price controls?

[SheetWise]

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In this case, price controls only affect efficiency if supply can shift.

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What would motivate people to quickly shift the supply, if the price is controlled? I can quickly get all the plywood I want if I'm willing to fly it in or truck it in -- if I want it at the same price it was at it's going to have to come by rail, and take six weeks. Supply can shift because demand allows prices to shift.

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I generally do not support price controls, but believe that other forms of intervention that can help foster competition are often necessary.

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You believe that market intervention can foster competition?

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It depends on the sector. Nobody is building a hotel in a week to take advantage of a hurricane.

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You'd be surprised how quickly that beach could be lined with 5-star motor homes and all the support services -- in an open market.

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Obviously supply does not depend upon benevolence. What does that have to do with anything?

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Only that it is the incentives provided by higher prices that allow the market to quickly supply an artificially high demand.

[FishHooks]

The price gauging law created in florida was a big mistake, let the free market run its course.

[sam h]

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That assumes that prices are not held artifically low. If there are price caps, supply will decrease, not increase.

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When I referred to the abstract market system, the assumption is that there are no price controls. Of course price controls can shift the supply curve, but not in the short term example we are discussing.

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Such as? And when *would* you support price controls?

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I would hardly ever support price controls. But in some situations such as war-time economies, they may be justified.

Other forms of market intervention to increase/ensure competition are incredibly common, especially in complicated sectors like telecommunications.