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10/23/2005

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Cogliostro Demon

Great topic.

I live in Florida where storms batter us from time to time.

Last year our local police made a big deal about arresting a man for, "price gouging." It seems that a resident of Nashville, Tenn., read in the paper about how many residents were without power. He went to his Home Depot, bought a ton of generators, loaded a truck and drove to Palm Bay and held an auction. He was arrested and his goods detained. Florida's Attorney General, a member of the Republican branch of the oligarch party, Charlie Crist, made a big deal about stopping gouging. "I fully support a business' right to make a profit, but we cannot accept unjust profiteering, especially when it puts an extra burden on citizens who have just endured a significant hurricane," said Crist.

Had Charlie been truthful he'd say, "We only pretend to believe in a free market. If we allowed market forces to set the price, needed goods would flow into the areas that need them. I know price gouging laws hurt the victims of storms by keeping them from getting the goods they need, but, hey it makes me look good to the unthinking majority who votes."

Sage_1776

For Grumpy Old Manís comment, both Posner and Becker are right on who made the extra profits from gouging; it is a matter of time frame. The gas stations made extra profits while selling the gas in their tanks, but were squeezed when they bought new fuel to refill them; the unaffected providers than made higher-than-average profits when they sold fuel to the gas stations. Of course the insurance firms, affected fuel providers, and consumers lost.

Cogliostro Demon

Ken Z @11:38,

First, relax, it's a blog.

Of course there are laws of economics. Take, for example Gresham's law, "bad money drives out good." You can take all your alleged, "democracy and democratic institutions," and pass all the legislation you can dream up, but when you introduce dimes with no silver, the silver dimes will vanish as quickly in our lifetime as they did in Sir Thomas Gresham's day.

The laws of economics are as fixed and immutable as the laws of physics, which as we all know are entirely relative. Convene all the legislatures you want, a scarcity of supply increases price. Pass all the democratic bills you want and capital will still confiscate the excess value of a man's labor.

ben

David

The fallacy here is that, when price gouging occurs, the price is not a true measure of supply and demand.

I think this would be true when a disaster causes a failure of the market and competition itself. But neither you nor Posner allege Katrina caused such a failure. Your contention seems to be that in a functioning market a sharp reduction in supply will create conditions so that it is in suppliers' interests to raise prices above equilibrium.

This cannot be right, because it means suppliers are forgoing profit. Starting from above equilibrium price, suppliers could increase profits by lowering prices and selling more. Because the price starts from above equilibrium, the additional volumes must more than compensate for the lower price. In fact that is what defines an equilibrium: it pays suppliers not to deviate from it.

Provided the market is functioning (and by that I mean at a minimum that suppliers know the state of their reserves and distribution capacity, and consumers have some prices information), price must be a measure of supply and demand because if it is not then opportunities for profit are not being exploited. True, temporary deviations from this will occur by mistake. But I think Posner's point holds in a functioning market.

Paul Gowder

Lets talk about the distributive effects then. Judge Posner, would you support or oppose a 100% tax on all profits gained from a temporary, natural-disaster related, shortage, to be distributed among the victims of that disaster? (In this context, this means a 100% tax on the profits received above and beyond the pre-disaster profits expected from an equal quantity of sales.)

After all, you can't argue that the extra profits are needed to provide an incentive to continue selling e.g. the gasoline. After all, gas dealers stay in business during non-disaster periods, and there's no evidence of which I'm aware suggesting that the opportunity for disaster profits has encouraged some dealers to enter the market.

I have a second, wholly separate question. What if there isn't really a meaningful drop in supply? For example, during the period immediately following Katrina, were there ever actually (except directly along the major evacuation routes) actual gasoline shortages, as shown by people willing and able to buy gasoline who could not buy them? Oil was released from the strategic reserve, as I recall. Was there ever an actual need for the rationing effect of price increases? Or were gasoline sellers merely reacting to an inaccurate perception of such shortages by the public?

(You may reply that the higher prices reduced demand, thus preventing shortages. This is where empirical data would be helpful. If anyone has such data, please provide it.)

mike riikola

I confess I haven't read all the comments, so I don't know if others have pointed this out, but the judge's distinction between "natural" and "artificial" scarcities is not ultimately convincing. The oil producers knew that hurricanes are perfectly foreseeable in the Gulf and that their production facilities would be badly affected by such storms. Now they are trying to shift the costs of their failure to manage their own risks back onto consumers by raising prices. So it is not mere supply and demand which determine the price in the events of risk-management malpractice in light of foreseeable natural disasters; instead, it is the usual type of duress that the judge otherwise condemns: it is extortionate to put consumers under duress by habituating them to artificially low prioces (propped up by their failure to mitigate their potential risks by strengthening or geograhically dispersing their productive capacity) and then backcharging them for the producers' own risk-management malpractice.

Joe Merchant


Lots of free-market purists here....

A truly free market leads nearly inevitably to monopoly, negating its good aspects. So, we regulate to discourage monopolies.

A truly free market comoditizes labor, hiring and firing at the whim of a new business plan - not good for skilled labor development, so a balance is struck with some thin layer of job security for skilled employees - not much fun to live in, but I'll wager most of us are living in this condition today - or toiling for severely substandard wages in "secure" positions.

A truly free market allows infinite price volatility - your Big Mac might cost $7 at noon, and only $0.70 at 3pm. This has been tried, it's offensive and drives customers away. People prefer some predictability in their costs.

Problem is, when an entire industry that is linked into the base of the economic food chain (like energy) jerks around their pricing too much, justifiably or not, it puts chaotic inflationary ripples through the entire economy. Many lucky businesses of all types will get rich off of the chaos - unlucky ones, even when well managed, can be put out of business in the turmoil.

Question is, what kind of world do you want to live in? I don't like hourly price swings for restaurant food - I can vote with my feet there. I also don't like massive profits posted to energy companies in the name of crisis control - unfortunately, my only voting influence there is at the ballot box.

ben

Joe

Where to begin? That free markets lead to monopoly is an old claim and it is wrong. As Bork (1978) said: "The congealing [i.e. increasing concentration] of the economy has been prophesied freely since at least the debates on the Sherman Act in 1980, always on the basis of overwhelming current trends, and it never comes to pass." It still hasn't. It won't. In unhindered markets you get monopoly in precisely the areas where monopoly brings efficiencies. Online trading is provided by a monopolist in most countries because it pays to have all buyers and sellers in one place. But atomistic competition appears where there are no efficiencies in scale e.g. web site development. Both are essentially unregulated markets.

Where it is easy to fire employees it is easy to hire them. Europe has persistently higher unemployment than the US in part because it is harder to sack workers there. Job security need not be undermined by less security in any one job: the unemployed don't generally stay out of work long in high employment economies.

You contradict yourself by saying that "[a] truly free market allows infinite price volatility" but then saying that it is competition which actually prevents such volatility when "I can vote with my feet". Your second point is right: competition disciplines firms not to do things that annoys their customers. So where your idea of free market price super-volatility comes from is a mystery.

when an entire industry that is linked into the base of the economic food chain (like energy) jerks around their pricing too much...it puts chaotic inflationary ripples through the entire economy

The recent spike in energy prices is notable because it has not as yet caused a slowdown in the global economy. So where's the cheese, Joe? Where are these chaotic ripples?

jaimito

Important point: There are many price control laws out there and they are not enforced. We have a more or less free market only because people wants it, not becasue of constitutional or legal guarantees.

pj pro

Actually, for the most part the Constitution protects Amercicans from government, grants us individual liberty and a rights to private property. It is through free markets in which these liberties can be granted and guaranteed. So, implicitly the Constitution does set up a free market system. It is only when government intervenes that this system is inefficient at allocating scarce resources with alternative uses, such as price controls.

mike riikola

What's frustrating about this thread is that most commentators are missing the main point: if the judge will tolerate price "gouging" in "natural" disaster situations but not in man-made ones (in which he, in harmony with admiralty and other law, condemns the practice because of "duress"), and if that distinction is faulty (because ex post facto fluid recovery of the consequences of your own risk-management failures is extracted from consumers, exactly because they are under duress due to circumstances), then the judge is really up to something else when he supports the practices of the oil companies.

What could that be? It is the usual game the U-Chicago Law and Economics crowd plays. They postulate premises which may or may not exist in fact (i.e., the "enlightened self-interested Economic Man;" the existence of "efficient markets" in which lots of participants have perfect information - - an especially laughable premise; etc.), and then pronounce that laws should do one thing: encourage the movement of resources to their "highest and best use," defined as that which the highest bidder defines by her eagerness to bid. And voila! Well-being is maximized for all! Never mind that the premises are dubious in the extreme or the consequences turn out in fact to be drastically bad for many in the short and long terms.

A legitimate objective of democracy is to provide a basis for managing the "life risks" of the less fortunate; that some "inefficiencies" occur is no more intolerable than the massing of great amounts of capital in the hands of insurers to pool against risk, shifting to them the right to make decisions on how resources should be allocated.

The judge has a bias for the status quo, for his brand of laissez-faire, "pragmatic" capitalism. With the utmost respect, this fact is nothing that the critical legal studies movement didn't predict and recognize a long time ago.

Corey

Oh how predictable, Posner is against price controls and accuses anyone who disagrees of being ignorant of economics.

I was well educated in basic economics, fortunately I was also educated in basic democratic, moral, and political theory. That wider outlook allows me to conclude the following, even conceding that Posner's economics are correct.

Lets be Tort lawyers instead of Contract lawyers for a second...

The concern of price-gouging laws is not price but rather distribution of costs. When a natural disaster occurs, there are material costs that are covered by insurance. There are also supply reduction costs... massive, uninsured, with no one to fault. That cost is going to fall on someone. How it falls is a function of legal and market architecture.

Ability to raise price functions like insurance against these costs. Producers/suppliers affected by the disaster can pass on costs to consumers. Indeed, they can apparently even show an increased profit.

For the consumer, ability to consume less is a way to avoid the costs, unless the good or service is a necessity. Gas is a necessity.
Consumers cannot reduce their consumption below that needed to get to school or work via car or public transport. They need to drive to the store if they are to eat cake. Thus, consumers absorb supply costs.

You might say, great, the cost was distributed widely, and that is the best possible result of a bad situation. But the cost was distributed regressively. The entities with the largest surplus of funds (gas companies) paid 0% of the supply reduction costs. Teachers and factory workers and engineers and salespeople and especially truckers were already struggling to get by, but they felt a real added pressure from the price increase.

That isn't fair, for the same reason a flat tax isn't fair. People don't like it. A majority of the population in this democracy that we live in doesn't like it. Hence, politicians that seek re-election (as opposed to academics and judges with tenure) also don't like it, even if they were once economists.

Many people in this country have the funny idea that corporations are chartered by the state in order to provide services to the people. People get annoyed when corporations escape damage from disasters while they do not. Perhaps Posner also views this as a failure of education.

I find it particularily ironic that after a long post trying to establish that price controls = protectionism = bad, Posner then seeks to protect American markets from influence by foreign powers that control large oil interests. How is it that Posner can see how concentrated foreign oil interests harm American interests, but does not recognize the same harms when consolidated corporations like ExxonMobil exercise their market power.

Price controls restrict the free market. Inelastic demand restricts the free market.
Price controls allocate supply reduction costs progressively. Inelastic demand allocates supply reduction costs regressively.

Natural disasters inject a massive cost into the market, absent regulation, where it lands depends on the distribution of market power. Not acting amounts to a positive preference for assigning the harm to the poor in proportion to their need for the commodity.

Elton

Gas is a necessity.


For some, yes. And that's why the higher prices in a crisis are essential -- it's the most effective rationing system, by discouraging people from doing unnecessary driving and leaving more fuel for those who absolutely need it. The market prevents an egregious loss of time for those who need gas (who would be stuck in shortage-induced long lines at the gas station), at the expense of higher prices. Those who wish to still trade off time for gas money can still do so by car-pooling, walking, taking public transportation, or any other method that is too inconvenient compared to driving under normal circumstances. A majority of the people in this democracy that we live in may not like it, but they would like the alternative much, much less.

ben

Corey correctly recognizes that the fundamental question here is whether price or non-price rationing under reduced supply is preferred. How to allocate a scarce and essential resource? I also think he is probably right that price rationing is less progressive than non-price rationing, if the willingness to queue for supplies under non-price rationing is negatively correlated with income.

I disagree on other points he and others have made. Although high prices will undoubtedly put gasoline temporarily beyond the means of some, I doubt this is many people. This will be the subset of people who can afford a car and pay for gas at $3.00 per gallon but not at $6.00 per gallon. I do not think non-price rationing for the whole population can be justified even in part for the sake of these few unfortunates. Targeted assistance is instead much more sensible.

The costs of non-price rationing have been somewhat overlooked. For some people the inability to get access to gas short of queuing for hours will be exceedingly costly. Non-price rationing thus also fails in some measure on fairness grounds, as well as efficiency.

A couple of other responses. 1) Energy-reliant corporations most certainly have been hit by energy prices, most notably airlines. 2) Gas is a necessity, but there are ways to reduce consumption by making better use of every gallon and high prices encourage that.

Corey

Energy reliant corporations can also to some extent pass on costs. Airline tickets went up, cost of groceries went up. It isn't just gas consumption that consumers are being asked to reduce.

We could argue for weeks about whether or not the average consumer can "afford" to reduce their consumption enough to compensate for the recent Consumer Price Index jump. You can dig up anecdotes about poor people driving SUVs, I can find several million people forced to commute over 100 miles each day because jobs and affordable housing are not co-located.

Poor people don't drive around burning gas for fun. They know more than anyone posting here about conserving and budgeting and living within their means. This gas price jump hit the lower and lower-middle classes hard. It hit rural areas harder than cities, and sprawled cities like LA or Indianapolis harder than places like NY or Chicago.

If you can come up with a targeted subsidy for that situation then great. The problem is that disasters arise quickly and prices rise faster than targeted bailouts can be designed. The price gouging laws operate to fix costs where they first fall until the state or private insurers can respond with relief. Distributed costs are harder to relieve or insure against.

And reducing supply in this situation is (by the same logic) also not an acceptable option. If Shell loses a pipeline, and is restrained from passing on the shortage by raising prices, why should it be allowed to reduce output and cause queues, provided the capacity can be covered from another source. Sure the cost will be higher for Shell, but it was Shell's supply-chain asset that was damaged, and Shell is both the most able to pay and the most efficient insurer or bailout target.

There will certainly be situations where there are no options for providing the commodity from another source. But the gas delivery system in the US is highly redundant. The gas price jumped nationwide in response to a localized event. The supply reduction in one area could have been mitigated through the reserves via other delivery methods (at least much more than was done).

Of course economists will scream that I am a socialist for characterizing the oil/gas industry as a public utility, but I would refer them to the large number of countries worldwide that seem to see it my way.

mike riikola

Corey, I'd take it one step further than you: the oil companies, fully aware of the perfect foreseeability of storms like the ones that have happened, failed to manage their risks. Now they should be permitted to, as you pointed out, regressively tax their customers to mitigate their own risk-management malpractice? Meanwhile, Exxon NETS $10B in profits (reported today by the WSJ)? By Posner's own logic, this is bad economics and bad law. It encourages the movement of resources to the lowest and worst use - - that of bad managers who have been proven beyond any doubt to be bad at what they say they will do.

That's why I made the point that Posner really doesn't believe it himself. He couldn't. He, instead, prefers the comfortable shoes of orthodox status-quo-preserving law-and-economics half-hearted resource-allocation rhetoric.

sands

for those interested check out www.cafehayek.com (and drudge) to see the ails of price controls.
a short aside: for those who think it's bad when companies generate profits, companies distribute the profits to invest into the company and hire more workers which will inevitably include the people who were the hardest squeezed (or they will pay them to their shareholders.)

mike riikola

Sands:
Maybe. That is if you assume that they are competent managers, which they have already proved themselves not to be (they ran huge risks without protecting themselves with adequate risk management practices and now want to tax consumers to make up for it). It is just as likely that they will do something equally stupid with these "profits" (more accurately, exactions) as it is that they will behave competently.

Jim S

Sands obviously has a lot of knowledge about what corporate executives should do with their profits in theory. Unfortunately it has absolutely nothing in common with what modern American corporations actually do.

David

Ben writes:

"Provided the market is functioning (and by that I mean at a minimum that suppliers know the state of their reserves and distribution capacity, and consumers have some prices information), price must be a measure of supply and demand."

I agree, of course. "Price gouging" by definition arises from a market failure: perhaps suppliers see a natural disaster, like Katrina, as an opportunity to hold back supply and artificially raise prices.

I do not know whether the recent increase in gas prices is due to real reductions in supply, price-gouging behavior, or a combination of both. Sustained "price gouging" would require, most likely, some sort of collusive behavior among competing suppliers. The announcement today of Exxon's 3rd quarter profits raises the fear that something is rotten in the industry, but it is only speculation at this point. I suspect we will find out more in the coming weeks and months.

If the recent spike in oil prices is a true reflection of the market, then so be it. I would not advocate massive intervention in the oil market just because gas is $3/gallon. That's still the same price in real terms that Americans were paying 30 years ago.

One caveat: in a really serious crisis, with a really serious shortage, price controls and rationing might be necessary to make sure that all people, and not just the wealthiest, have access to gasoline and heating oil. There are emergencies in which other factors outweigh the "efficiency" of the market.

ben

David

It seems to me a price gouging test could be developed. Conceptually it would go like this:

1. Did emergency x cause a reduction in or elimination of competition in market y? i.e. was there market failure

2. If so, did the prices and/or quality of products supplied in that market during its failure reflect supply and demand conditions as if competition had continued unhindered through the emergency. If not, gouging is defined.

This is like a use of dominance test in competition law, and I think it's workable. Some markets will be easier than others to estimate a competitive benchmark - gasoline would have to be among the easier given the market data available and its homogeneity.

To help make this workable, we might define a few short circuits: if a supplier runs out of stock during the emergency then if anything he has underpriced and gouging cannot be defined. If there is evidence of consumers shopping around that will help rule out market failure. Benchmark against comparable markets where competition is working.

One other possibility is that there was no market failure but there was collusion. Competition law already captures this.

It's certainly preferable to the current situation where any price increase in an emergency could put you in court.

ben

Joe

You claimed high energy prices cause "chaotic inflationary ripples". The latest Blue Chip consensus has US real GDP growing at 3.1%-3.3% per annum for each of next 6 years. Inflation is a steady 2.4%-2.5% for that period. Chaos?

"Where's the cheese? - $26 billion in increased revenue for Exxon in 3 months"

So what? a) That's not money down a black hole. b) The high prices that produced that surplus are not functionless and come with the triple benefits of stimulating oil exploration and production, encouraging efficient use, and encouraging development of substitute technologies (like hybrids). c) it has nothing to do with inflationary ripples, or chaos, or cheese.

Matt

It seems that there are a lot of comments justifying price gouging in this situation by saying that the market isn?t functioning correctly or that competition is restricted. I?m not sure this is really a significant issue since the barriers to entry are not nearly as dramatic as they are in the Alaska Packers and salvage cases.
The problem is that there isn?t enough gas. People are great at finding creative ways to make money, and if outrageous profits are allowed to a few, people will find a way to solve the problem as quickly as possible.

Elton

"If there are those who abuse the free enterprise system to advantage themselves and their businesses at the expense of all Americans," he said, "they ought to be exposed, and they ought to be ashamed."

That's a quote from Bill Frist in a New York Times article about people complaining about oil company profits. That is such garbage. If there is price-fixing afoot, then by all means investigate it and prosecute to the full extent of the law. Otherwise, using the enterprise system to advantage themselves is what companies are required to do, lest they open themselves up to shareholder lawsuits. Competition will take care of the rest. Gas stations are the most visible example of competing companies undercutting each others' prices to attract new customers. Frist is implying that either there is a price-fixing going on, or that consumers are no longer shopping around to get the lowest price, or that he doesn't believe in letting the market set prices. He should just say which one it is, rather than vaguely attack Big Oil. And will he call for subsidies to Big Oil when oil bottoms out again and Exxon is temporarily losing money? Don't think so.

In the same article:
"The industry says a windfall profit tax would limit investments," said Philip K. Verleger, a consultant and a former senior adviser on energy policy at the Treasury Department. "That's wrong."

"You can come up with a tax that would not impact investments but might in fact stimulate them," Mr. Verleger added. "You allow the industry to recoup its investments and make a good return. Then you look at incremental revenue and tax that."

Many people seem to think the government should make industrial policy for the oil companies. That it's a snap to impose just the right kind of taxes that will make Big Oil less profitable and more productive at the same time. Keep dreaming. Oil companies invest their money in increased production because they predict they will profit from it. Is it the government's job to decide what a "good return" for a company is? Remove some of the reward for future production, and oil companies will find better uses for their money than investing in themselves.

Paul Gowder

Hold on... hold on... those profit figures are very revealing, because they seem to add substantial evidence for Corey's point about low elasticity of demand. The percentage increases in the profit of the major oil companies from last year, as summarized by one Arizona article (linked from my own blog), are as follows:

Exxon: up 72%
Shell: up 68%
Conoco: up 90%
Chevron: up 53%

this is an average increase of 70.75%. Did gas prices over the same period increase by a significantly higher amount? If not, and assuming there was no factor other than gas prices that significantly contributed to higher profits, it would seem like there is a direct relationship between profits and prices in the industry. The curves are parallel. This means that price didn't affect demand at all!

Thus either gas was priced below equilibrium before Katrina (very generous of the oil companies if true, but I rather doubt it), or there is next-to-no elasticity of demand for gas (because largely of our lousy public transportation in this country) and higher prices do not in fact ration use at all.

(Anecdotally, this is very slightly supported by the fact that there were gas lines in Houston, as reported by a friend on scene, before Rita notwithstanding presumed price increases.)

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