Response on Price Gouging-BECKER

Although I am a little late, I would like to respond to a few comments on my discussion of price gouging. Judge Posner's and my discussion of our new topic on childcare and paid leaves follows after this response. Two of the comments questioned my assertion that President Carter introduced price controls on gasoline that produced long lines. I am right, as shown by the following entry from Wikepedia on the 1979 energy crisis: "In the United States, the Carter administration instituted price controls. This resulted in long lines appearing at the gas stations as they had six years earlier. As the average vehicle of the time consumed between 2-3 liters of gas an hour while idling, it was estimated at the time that Americans wasted up to 150,000 barrels of oil per day idling their engines in the lines at gas stations." To be sure, Nixon introduced various inefficient controls over energy prices that Carter began to dismantle. However, Carter introduced controls over gasoline prices that produced I believe longer lines at gasoline stations than those under Nixon. Of course, I agree that Nixon had terrible policies on energy prices, especially his misguided efforts at price controls over oil, natural gas, and some of their products. Although search is required to discover prices at different gasoline stations, in any major city or suburban area, search costs are small relative to the gain from sizeable differences in gasoline prices. This is why the retail gasoline market is on the whole very competitive, as indicated by the strong central gasoline price tendencies in major cities and other extensive markets. In such competitive markets with rather constant costs per unit of output, the effect of a rise in input prices on retail prices is largely independent of the elasticity of demand for the retail good. Unfortunately, many Indians, Chinese, and others in poor countries live on the equivalent of less than a few dollars a day, and many of these suffer from malnutrition. But this has nothing to do with price gouging during crises since most of these persons live in rural areas and work on farms. It is the result of their very low productivity. As India and China have progressed rapidly during the past decade and half, the fraction of their populations living at such low levels has declined dramatically, and so has the degree of malnutrition. Gasoline prices have returned close to pre-Katrina levels because most of the damaged refineries have been repaired, and the undamaged ones have increased their production. Both effects are in part responses to the (temporary) high gas prices. So my conclusion is that these high prices served a very useful purpose in increasing gasoline supplies more quickly that would have been the case if price controls on gasoline had been introduced again.

Comments

[Nick R]

It's saddening that the public and press are so economically illiterate that Prof. Becker has to explain essentials of the price system. "Price gouging" is an example of a topic where mainstream journalism is irresponsibly AWOL. Has anyone ever seen a balanced article in the mainstream press on why prices go up during shortages? On the other hand, how often to we see articles in all the great organs of the media about oil company profits--though never, of course, in a historical context that would show that on average, their returns on investment are pretty middling. Also disconcerting is that some economists have jumped on the "price gouging" bandwagon, such as John Irons in his recent WSJ blog.

[Ken Zimmerman]

Quote from a source who has worked in the fossil fuel area for over 50 years, backed up by many with equivalent experience pointing out in the simplest terms possible why economists should never be allowed to set the price of anything that means anything to people's lives!

The message now should be to try to be more cheerful consuming less, because there is less left to consume, especially oil-based energy. The price of natural gas in Britain is soaring, such that energy costs for a typical household have increased 36% since January, with the power companies blaming dwindling North Sea reserves. This may be the beginning of a pandemic, with threats of demonstrations and industrial action reappearing in various places. In a certain sense, they are justified because the costs of producing oil and gas have not changed materially: the higher prices are simply profiteering from shortage, which is a normal attribute of flat-earth economic markets, not designed to cope with finite resources lacking competitive substitutes.

[ben]

It's this kind of post that makes me sad. A total of four posts from Posner and Becker explaining the clear benefits of price increases under shortages, and why profits are a normal side effect of this, and the tremendous costs of not allowing prices to rise, only for Ken to ignore all of that and claim profiteering. What a howler.

[Joe Merchant]

Ben,

Although it is "their page", I think the whole point of the comment section is to present other perspectives.

If we all just cheer their observations and bash anyone with a different idea, what's the point of having comments at all?

[ben]

Joe

What I am saddened by is the implied snub and the refusal to address the argument. An argument to the effect of, "I don't care what you say, it's still profiteering" is useless, and worse than useless if anyone is actually persuaded by it, even if the position turns out to be correct. Nothing is discovered through dogma.

[Max]

Judge Becker,

two short notes:
First, I think you made a typo, it should be "Wikipedia," not "Wikepedia."
Second, while I am an avid Wikipedia user (and anonymous contributor), I recommend caution when citing it as an authority.

There is a very high likelihood that the Wikipedia entry on the gas shortages is correct. Nonetheless, despite the best efforts of Wikipedians, the collaborative nature of Wikipedia means there is no one point in time at which any entry can be definitively said to be correct; you may have caught it in a short interval between informed posters and uninformed posters, when erroneous information was added.

[craig]

The media suggests price gouging, some oil companies are making supposedly record quarterly profits, and the price at the pump is higher. It has been suggested that adjusted for inflation, gasoline is priced about right. All of this high level bickering, statistical analysis, and media coverage, and I'm still broke at the end of the month. I'm pretty sure that my situation is not abnormal. So what needs to be done? A new law, another level of bueracracy, a hearing on the finer points of an oil executive's parking spot, or maybe we need a leader that cuts through that garbage. Well I can dream anyway.

[Dale Gribble]

"Gasoline prices have returned close to pre-Katrina levels because most of the damaged refineries have been repaired, and the undamaged ones have increased their production."
Interesting, as retail gasoline prices have fallen below levels preceding Katrina, diesel remains exceptionally high and just went down $.28/gallon this week.--no doubt a function of high inelasticity of demand for diesel powered transportation
diesel retail: http://tonto.eia.doe.gov/oog/info/wohdp/diesel.asp
gasoline retail:
http://www.eia.doe.gov/oil_gas/petroleum/data_publications/wrgp/mogas_home_page.html

[Howard]

The comment about Wikipedia is well taken. The Carter-era shortages were indeed the result of policy and price controls, but the controls were not Carter's doing and the shortages were not so extensive as those in the wake of the OAPEC embargo. The shortages were fairly widespread in parts of California, but relatively rare elsewhere. Carter was not pushing new controls, but rather proposed phased decontrol, removal of the controls imposed in the Nixon Administration. But the old controls were still in place and really started to bite because of the effects of the Iranian revolution.

Actually, the Nixon-era controls illustrate Professor Becker's point better than the Carter experience. Under the earlier controls, prices were capped by supplier depending on the supplier's access to controlled-price domestic crude. Ohio, whose refiners were not terribly integrated into domestic production, experienced no shortages -- just higher prices. Illinois, served at the time by companies like Amoco that were relatively well supplied with domestic crude, had long lines and nonsense like odd-even rationing. One Illinois station offered gasoline at low prices. Its owner reasoned that to buy at a low price, consumers needed to be lucky, and offered to sell rabbit's feet that would provide the requisite luck. The shortages eased after the introduction of the entitlements program that grabbed domestic crude oil rents and offered them to refiners who imported foreign crude.

This was all part of Project Independence, which obviously should have been called Project Dependence. One result of that program was the building of lots of small refineries in the U.S. even as refinery capacity was shrinking everywhere else. The net result of this idiocy was that our new refineries were too small to be efficient and couldn't process low quality crude. The Wall Street Journal reported that one refinery was cobbled together, shown to DOE inspectors, and vanished as soon as they left. The game was to import foreign crude in order to gain access to below market domestic crude. The refineries were small because the formula for giving out the goodies contained a small refiner bias.

Where did the high quality crude come from? Our good friends in North Africa, Libya and Algeria. During the Carter-era mess, these guys were able to increase crude prices to (as of then) unheard of levels, waaaay above the prices of Saudi crude (typically lower quality in that it was not "sweet"). Once prices were decontrolled, the small refineries tended to go belly up and the cross-hauling of crude that had developed went away. This meant that we were no longer buying a lot of Libyan crude. It is mere speculation on my part, but it is certainly possible that Reagan felt free to drop a few bombs on Libya because our dependence on them for crude had ended.

The big price increases for crude occasioned by the Iranian events likely caused the old retail controls to bite for the first time since 1973-4, but I do not believe that the shortages can be laid at the feet of Carter (How about placing them at the feet of the University of Chicago's own George Schultz?) . Indeed, Ted Kennedy, running for Carter's job, managed to demagogue the issue rather effectively, calling for mandatory conservation and price controls.

[Felix Mendelssohn]

Professor Becker:

I am interested about your opinion on the signature of a Free Trade association with a country like Argentina. In the following days there will be a meeting of the american presidents over there and that is a topic in which many are interested here ( Argentina). The people naturally guided by political ideas, that in the most of the cases are induced and have no real contact with reality, tend to reject this kind of documents. Notiving the big differences between the economies of both countrys which would be your recommendations?

Thank you very much

[Crystal]

Urghhh, that spam comment is really obnoxious, somebody needs to delete it!

Now as far as the price gouging complaints, it totally baffles me to hear Americans complain of high gas prices, I mean, gas is almost as cheap as milk and in most of the world it goes for 4x the price we're paying. I really hope the price will go higher actually, to encourage more people to support public transportation. In Chicago there is talk of a fare increase on CTA and I find it really annoying the state gov't isn't kicking in more to preserve our city's mass transit system. I haven't owned a car for years and being being mobile was quite a struggle when I lived downstate, because of the paltry public transport. If the net effect of supply-demand pressures encourages more people to carpool, walk, bike, bus-it etc., then that's great!

[Bill]

The Wikipedia entry on price controls is wrong. The long lines for gasoline occurred in early 1974, due to a combination of the huge worldwide spike in the price of crude oil (and therefore in the equilibrium price of gasoline) and the *preexisting* system of wage and price controls instituted by the Nixon administration in August 1971. When the complete failure of wage-price controls to dampen inflation became obvious during 1974, the system was abolished--with the single exception of price controls on domestically produced crude oil.

The little-remembered President Gerald Ford actually signed legislation authorizing the elimination of oil price controls effective on his last day in office, but those controls were reimposed immediately by the Carter administration. I believe this is the source of confusion.

In short, it Nixon who regulated retail gasoline prices (along with all other prices), Nixon who abandoned all price controls except those on domestic crude oil, Ford who (fleetingly) decontrolled domestic crude oil prices, and Carter who recontrolled domestic crude oil prices.

[roque]

Buena noticia, no tenia idea de eso que estaba pasando

[Rob H]

Bill,

I can't attest to the validity of the Wikipedia entry, but I think you are clearly wrong that long lines *resulted* from a higher equilibrium price of gasoline. High prices would discourage consumption and shorten lines.

[Matt R]

It's the Refineries. The fact is the domestic oil refiners have an incentive to underbuild. Under normal conditions, the refinery capacity might be adequate to meet ordinary demand. The refiners might even make a little more money if they built extra capacity for demand peaks. The thing is, they make A LOT more money ($50 Billion for Exxon?) if they do not build that capacity and there is a shortage. Simply, the supply curve (short term domestic) is much steeper if they don't build that extra capacity. When there is a shortage because of a hurricaine or whatever, the profits are huge compared to what they would be in the same circumstance if the refiners built a litte more capacity. Because of this incentive, they may actually underbuild vs what is required to optimize even normal demand. It's a kind of passive profiteering. Draw the little rectangles under the curve for relative profits (or read Exxon's quarterly), and you will see what I mean.

[Bill]

Rob,

The long lines were indeed the result of price controls preventing gasoline retailers from charging the equilibrium price. An excellent summary of that particular period is available here:

http://www.pbs.org/wgbh/commandingheights/shared/minitextlo/ess_nixongold.html

Here's the most relevant excerpt:

"Nixon, under increasing political pressure from the investigations of the Watergate break-in, reluctantly reimposed a freeze in June 1973. Government officials were now in the business of setting prices and wages. This time, however, it was apparent that the control system was not working. Ranchers stopped shipping their cattle to the market, farmers drowned their chickens, and consumers emptied the shelves of supermarkets. Nixon took some comfort from a side benefit that George Shultz, at the time head of the Office of Management and Budget, identified. 'At least," Shultz told the president, "we have now convinced everyone else of the rightness of our original position that wage-price controls are not the answer.' Most of the system was finally abolished in April 1974...."

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