Price Gouging in the Wake of Hurricanes--Posner's Response to Comments
There were many excellent comments. One asked who actually benefited from the shortage of gasoline resulting from Katrina and Rita--the gasoline dealers or the refiners? I had mentioned the first, Becker the second. Both gained, but the refiners more. The reason is, as one commenter noted, that once the gasoline station has sold all the gasoline stored on his premises and has to buy more from a refiner, he will have to pay the high price necessary to ration the limited output of the refiners, unless he has negotiated a fixed-price supply contract.
I was surprised by how many comments took issue with the basic proposition that price controls are inefficient. A number of questionable propositions, theoretical and empirical, were offered. For example, it was suggested that charging the market-clearing price in a shortage is inefficient because it is not the "equilibrium" price. I think what the commenter meant is that if the shortage is temporary, the price that clears the market will soon fall. But the point is that it is the market-clearing price. If a lower price is charged, supply will exceed demand and will have to be allocated by some nonprice method, such as queuing. It is quite right, as I had suggested in my post, that for people with low time costs, queuing may be preferable to paying a high (money) price. But the poorest people don't have cars, so they are not affected by a gasoline shortage. Above them are people of modest incomes, who can afford cars but are highly sensitive to gasoline prices; nevertheless, the number of people who would incur extreme hardship from having to pay an extra $2 or $3 a gallon for a few weeks is, I would guess, small (I would invite submission of evidence that it is large). Moreover, while their time costs may be low, they will not be zero. Queuing in a shortage situation can become extreme, because not knowing whether there will be any supply available people tend to queue when their need is not urgent, for example when they have a half-full gas tank but are unsure when, if they do not fill it now, they will be able to do so when the tank is almost empty. Fear of shortages also makes shortages worse and queuing longer by increasing hoarding. The worse that shortages are expected to be because of price controls, the more hoarding the expectation of shortages will induce--and so the shortages will be worse.
As I said in my post, in situations of extreme hardship, which I illustrated with the case of a shortage of human growth hormone and that one of the comments illustrated with the case of scarcity of organs for transplantation, the welfare effects of rationing by price may justify either nonprice rationing or a government subsidy to enable people of limited means to obtain a product much more likely to increase their welfare than that of affluent purchasers.
It should be noted also that some of the effects of shortages on the distribution of income and wealth are automatically corrected by the tax system: windfall profits of gasoline dealers and retailers are taxable as income, and so a part of them is in effect returned to the general public. More would be returned if an "excess profits" tax were imposed, as in World War II, in recognition of the enormous profits that shortages created by the nation's all-out war effect had generated for defense contractors.
One comment blamed the refiners for not having hardened their Gulf Coast refineries against catastrophic hurricanes. If they were negligent in failing to do so, this might conceivably support a tort suit to recover the refiners' windfall profits. (They would not be negligent if the expected benefits from such hardening did not exceed the costs.) For then there would be a sense in which the shortage was artifically induced. But the point does not support a general policy of imposing price controls during shortages.
One comment reported a rumor that Starbucks had charged $10 per bottle of water to firemen and police officers who responded to the 9/11 attacks in New York City, even though--the commenter said--there was no shortage of water. But the rumor, if true, describes a situation similar to that in the admiralty salvage case. The responders appear unexpectedly and need water; they don't have time to shop for it and anyway there are many more of them than are usually trying to buy water from a Starbucks store, and so its supply would quickly be depleted if it charged its normal price--so there would have been a shortage at that price. And, as one comment pointed out, price controls in shortage situations, for example in the form of fines for "price gouging," discourage merchants from stocking up with extra supplies for future emergencies. Keeping an inventory of items that will be demanded only in emergencies is extremely costly, and may be cost justifiable only if the merchant knows that should there be an emergency the items can be sold at a higher than normal price. This is an objection to a general windfall-profits tax.
Some of the comments challenge the most basic assumptions of a free-market society, such as that markets generally yield much more satisfactory allocative results than bureaucrats. One would think that the experience of communism would have disabused people of belief in the superior efficiency of "central planning." The issue is not philosophical--whether a market system of resource allocation is "just" or whether democracy should be used to allocate resources instead of markets because it is more--democratic. It is whether you like the consequences that "price gouging" laws would produce. The major consequences would be shortages, leading to nonprice rationing that would impose enormous costs, and thus augment and shift, rather than reduce, the price of the shortage item. I think the experience of queuing would change the minds of most intellectuals who think that resources should be allocated by nonprice methods.
Let me try finally to be more precise about the nature of the market failure in the admiralty salvage case. One comment suggested that the problem there is not monopoly at all, in the sense of an artifical scarcity, but transaction costs. In fact both monopoly and high transaction costs are present and they are related. The would-be rescuer creates an artifical scarcity by threatening to withhold supply (that is, refuse to rescue) unless the ship in distress agrees to the rescuer's exorbitant price--a monopoly price because it is based on the purchaser's lack of alternatives. However, the situation is actually one of bilateral monopoly because while the purchaser lacks alternatives, so does the seller; he has (at present) no other market for his rescue services than this particular ship in distress. Because price under bilateral monopoly is indeterminate within a broad range, negotiation (transaction) costs are high, which creates a particularly acute problem in a rescue situation in which time is of the essence. The case is completely different from that of the hurricane-induced gasoline shortage.