Comment on Price Gouging-BECKER

Protests against "price-gouging"in times of shortfalls in food supplies and other goods go back thousands of years. Alleged gougers and speculators have been hanged, assaulted, and ostracized. The recent energy bill passed by the House of Representatives has many good provisions, but also requires the Federal Trade Commission to set standards for "price gouging", and to punish offenders. Price controls emerged in virtually all countries, including the US, during World War II and other wars, when many products were in reduced supply. It might seem "where there is smoke there is fire", but I fully agree that prices should be allowed to rise to their equilibrium levels when supply is reduced due to natural and other catastrophes. As Posner indicates, attempts to suppress prices of gasoline or other goods that experience a great reduction in supply will require using less efficient ways to allocate the limited supply. The main alternative to higher prices is rationing in some form of another, such as selling on a first come first served basis, selling to persons willing to bribe the suppliers, and so forth. All these ways are inefficient, and discourage production instead of solving the problem of reduced availability of certain goods. Anyone who remembers the long lines and waits of an hour or more to get 10 gallons of gasoline after President Carter imposed gasoline rationing can appreciate the wasteful costs created by non-price methods of allocating a limited supply. Another example is the rent controls that many nations imposed during and after World War II. Most have since removed their rent controls, but certain cities like New York have kept them, although in a modified form. Most serious studies of the effects of rent controls in NY and elsewhere show that they speed up the deterioration of housing quality, they cause an inefficient allocation of the limited housing stock, and usually they harm rather than benefit the poor and the young who more frequently have to find housing in the rental market. Rent controls generally benefit middle class and older renters who often stay in large apartments at ridiculously low rents because it is too expensive to move to smaller apartments available on the open market. The angry reaction of consumers to high prices caused by a major catastrophe usually is not directed at the persons or companies that profit. For example, customers are now very upset at owners of gasoline stations as they have posted continual increases in prices due to reduced supplies of gasoline resulting from Katrina, and the rising price of oil. But the profits of most gas station owners went down, not up, after Katrina. They have to pay more for the gas they buy, and the higher prices cut back on the demand for their gasoline. It ishould be pretty obvious that a rise in the price of a major input in production, such as gasoline is to retail gas stations, lowers rather than raises their profits since costs of production have risen. On the other hand, profits have increased to operators of refineries that were not damaged by Katrina because the damage to Gulf oil refineries raised the wholesale price of gasoline, the main product of refineries. However, the higher prices and greater profits induced undamaged refineries to squeeze greater production out of their limited capacity, and companies hastened to repair the refineries that were damaged to cash in on the high prices. In fact, many were repaired in a remarkably short time. If price were not allowed to rise, profits of undamaged refineries would have been reduced, but the supply of gasoline would have increased at a slower, probably much slower, rate. Faced with cutbacks in supply, companies often voluntarily sell at lower prices to their regular and best customers to increase the goodwill of these customers, and also because there may be an implicit long-term contract with these customers to keep prices relatively stable. They sometimes combine low prices to favored customers with rationing of the quantities they give them, while raising prices sharply to their customers who buy less, or more irregularly. I have no problem with Posner’s two examples of legitimate use of controls over prices. In the salvage at sea case, controls are warranted because there is not time during a rescue effort to work out what would be the appropriate sharing rule. The attempt of the Alaskan seamen to hold up the owners for higher wages while at sea presumably broke an implicit contract that wages are fixed for the duration of the fishing trip. But shouldn’t price controls also be used in poor countries when they experience a catastrophic shortfall in the supply of a food staple, such as rice or potatoes (the Irish potato famine is the best-known example)? The poorest families may be unable to pay the higher prices, and they could face starvation. Still, I do not believe price controls are a good solution, for they discourage greater production and imports of the scarce food, and they encourage farmers to hoard their food crops. Governments of these countries, and richer countries too through humanitarian aid, should instead become active in buying rice or whatever crop is involved, and reselling that to poor families at lower prices. Or these governments should increase income transfers to the poor that would enable them to pay the high market prices. In the modern world, famines are caused not be high prices, but by bad governmental policies. Famines are virtually unknown in modern democratic societies. Yet famines and large-scale starvation are still sometimes found in dictatorships, such as in China during Mao’s Great Leap Forward. The problem there was not high prices, but Mao’s foolish policies. He first caused farm output to fall by his misguided attempt to leap forward,. He then forcibly took much of the limited supply of food from farmers, so that many of them starved to death, in order to feed city populations. In addition, he sold some of the reduced crop of grains abroad for hard currencies rather than importing grains to ease the food crisis.

Comments

[Z]

In regards to price gouging by gas stations after Katrina, you forgot to mention that demand for gasoline is relatively price inelastic; in other words, price changes in gasoline do not affect consumer demand a whole lot. Therefore, if future shortages in gasoline are predicted and the seller needs to change consumer behavior in order to meet future demand, then the only lever he has to curtail consumer demand is to really crank up the price.

[michael]

Not only do I do my part to conserve gas by ridding a gas saving scooter that gets 80mpg I run a website to bring scooters to all who have a need to combat the soaring gas prices. Whether the hurricane had anything to do with the soaring gas prices it certainly had a profound effect on sales of scooters with them tripling in a matter of days after the hurricane. We all need to do our part and scooters are a great way to put that cash right back into your pocket

[Claiborne Booker]

A question - was there gasoline rationing during the Carter Administration (January 1977 - January 1981)? A quick look at the history suggests not, which squares with my recollections as a young driver in Virginia in the late 1970s. I do recall the "odd-even" rationing earlier, which I believe was during the 1973 Arab Embargo (the Nixon Administration - he of the price controls). I distinctly remember scouting out gasoline for less than a dollar a gallon sometime in 1979-1980, much to my date's consternation.

[spencer]

There were no gas lines under Carter.

The gas lines were under Nixon.

Moreover, Carter did not impose price controls on gasoline. They were imposed by Nixon.

Actually, Carter lifted price controls. No he did not lift them 100% -- it was a phased decontrol. But in percentage terms, Carter actually did more to lift price controls then Reagan.

[Josh Doherty]

Price gouging does not occur as prices rise. The retail level price gouging happens as the cost of inputs (wholesale gasoline) falls and retailers hold price. Prices come down as consumers begin to search for alternative sources of supply and/or substitutes such as public transportation.

What appears to be a delay or sticky price in retail gasoline is likely a result of search costs and efforts by the consumer. If the stations in a 5 mile radius charge +/- a few cents per gallon, the consumer will expend much effort to search outside of that radius. However, as prices push the consumer to exand his geographic market, he will find lower prices and therefore put pressure on his original geography to to drop prices. This is a lengthy process relative to immediate increases at the wholesale level which are instantly shown in price increases.

An interesting thing is the emergence of web sites such as gasbuddy.com which allow consumers to inform each other about gas markets and therefore accellerate the time for all prices to fall as search costs go down.

[michelle]

What is modern is that gradually, a nation moves from a dependence upon the land to a 'castle in the sky' condition of creative destruction.(dictatorships don't work, ties don't always bind)

Yes, very, very, bad governmental policies can devastate a nation. Mao's plan for killing all swallows and his stubborn rejection of western technology certainly places him as a poor decision maker. I won't defend him.

Yet, looking at Japan, at least what Japan used to be, a healthy acceptance of new technologies is necessary. When American workers begin to despise the machines that make them 'unnecessary' then productivity will certainly be harmed.

So yes, though politics can matter a great deal, but people need to be engrained with a certain attitude towards technology as well.

Also, one last thing about Democratic India, many are starving. Starving is their condition, defined that way, in India there is a normalization of famine. What should we do about that?

[Edward Mensah]

Why have prices reverted to almost pre-Katrina levels in Chicago ( and other large cities)?. Gasoline prices for regular unleaded averaged about $2.87 per gallon last week in Hyde Park, Illinois, and I have not seen any $3.0 per gallon prices in the city in the last 2 weeks ( I drive my kids to school on the North side and I work on the near West side). Meanwhile, I remember similar or higher pieces in the pre-Katrina days. It was argued that the pre-Katrina high prices were due to lack of refinery capacity. Granted that being the case, one would have expected relatively higher prices when Katrina damaged more refineries. The Katrina effect was quite short-lived. What I suspect is that production and refining companies (sometimes owned by single companies) are increasing prices in response to the shortages induced by the turmoil in the Middle East and the huge demand by China. The role of refinery capacity shortages, while real, is quite limited. Why? I bet if we track changes in refinery capacity from 1998 to 2001 and compare it to changes in refinery capacity from 2001 to pre-Katrina, we will see no significant difference. Yes, refinery capacities have not increased significantly over the years but they have been stable until Katrina occurred. The Katrina and refinery capacity effects may have been exaggerated. Investors will increase refinery capacity when they see super-normal profits. On the other hand, if they know they can make profits simply by increasing prices why should they invest in the short-run? It will not make sense. However, the role of China and the turmoil in the Middle East are real and will not go away soon. China will increase demand on the world market and, peace in the Middle East, a pre-requisite for increased investment in oil production, will take time.
What this means is that high oil prices are here to stay. Given that high oil prices constitute regressive taxation since the poor drive older and inefficient cars and cannot afford Prius and other fuel efficient cars, does it not make sense to subsidize the poor, in the form of earned income taxes or some form of vouchers? Judge Posner states that ìthose who need the gasoline the most, not being able to express their need by outbidding other consumers for the limited supply, will suffer the most from the shortages.î I do not see any bidding on the corner of 47th and Woodlawn, or any other gas station. All I see every morning when I am driving my kids to school is change in advertised prices ( and it probably happens at night). In a perfectly competitive market, yes, bidding happens. But not gas stations in Chicago or else where.
Again, when Judge Posner gives the hormone injection example in ì the rare situation in which the consequence would be an intolerable gap between wealth and welfareî do increases in gasoline and heating oil prices not place intolerable gaps between the rich and poor, rich and middle class, in our society? If yes, I do not believe the market should be left alone to find its equilibrium. The market needs some help from regulators, for example, increasing gas taxes to keep the price at $3.00 per gallon and using the revenue generated to subsidize the poor and increase research into alternative fuel sources (including nuclear energy). That will not affect the role of China in the oil market but will make us less dependent on Jihadists (or jihadists).
Finally, I believe that Mr Beckerís argument that Governments of rich and poor countries become active in buying rice or whatever crop in order to save people from starvation. Makes perfect sense. Why should the same argument not be used to subsidize gas and fuel oil prices for the poor in our country as a national policy, given the inelastic demand for these commodities?

[Joe Merchant]

Tangentially related stream of conscious drivel follows:

Gas prices in Houston used to be relatively uniform across the Harris county area.... Today, there's a $0.25/gallon price differential across a distance of 8 miles (from $2.50 in Pasadena to $2.75 in Clear Lake) - not quite enough to make it worth your time to drive up and fill up on the cheap, but certainly worthwhile if you've got to go there anyway.

There never was a shortage of gas within the Houston Beltway, but during the Rita evacuation, and for at least a week afterwards, gas was in very short supply for at least a 150 mile radius outside of Houston, all stations drained dry, maybe one in 50 pumping because they just got a truck in. In the metro area, 49 out of 50 were open for business as usual. Some kind of non-market driven rationing caused that disparity.

By the way, during the evacuation, I paid $10 for 2 gallons of gas - and I would have gladly paid $20 for those same 2 gallons. They were the 2 gallons I needed to get to my destination, and after waiting 5 hours in a line that was only 30 cars long just to get to the pumps as they were shut off - I left that station before the riot broke out - when I found the next open station 50 miles down the road - my tank on fumes - it was time to do whatever it took, or weather the storm on the roadside.

Now, thanks to market demand, the pollution emission controls have been lifted on the refineries in the name of increasing output - maybe justifiable, but the other petrochemical plants have followed suit, and the enforcement agencies move at the pace of bureaucrats frozen in a glacier. Air quality has taken a huge turn for the worst this year - and respiratory problems are much worse for the residents.

There's a reason very few people retire to Houston, most people wise up to what's not good for them after a few decades. Housing is ridiculously cheap here, but skilled labor is expensive - two more marks of a place that intelligent people don't want to be.

The US economy needs the Houston Petro Chemical complex to function - it's our own little domestic third world zone, people die in explosions at the plants, everyone breathes the toxic mix of ash that they spew into the sky - but without the output from here, where would we get our Ziplock baggies, our WD-40, and the diesel oil that delivers food to your local grocery? One week with no diesel output from our refineries would see the start of famine in this country, a month after a sudden shutdown, I do believe society as we know it would be destroyed - that's called just-in-time or lean manufacturing, very efficient, don't keep more on hand than you need to - reduce waste, spoilage, storage reqirements, and inventory carrying costs. Luckily our refining capacity is spread around the country, not just located in Houston - so a single terrorist nuke couldn't bring us down that way.

And after those thoughts, who really cares about a little price gouging? Seems like the market is starting to correct now, anyway.

[ben]

A fundamental objection to the socialist perspective being promoted by some in this discussion is that their proposed remedies damage or destroy the institutions that gave us cheap energy and goods in the first place.

However unfair windfall gains seem, arbitrarily stripping wealth from private individuals can only provide short run gains to the beneficiaries of the transfer. Confiscation of property chills investment incentives, competition declines, the real cost of goods goes up and society's wealth suffers. Furthermore, it is not at all clear that confiscating property will ultimately reduce inequality. Black markets thrive where property rights are weak. Inequality in poor countries is generally high.

The implicit assumption of the socialists is that society's wealth is independent of property rights. To translate to the socialist lexicon, arbitrary large-scale violations of property ultimately produces fewer jobs, lower wages, less money for education and health, and shorter life expectancy. This is not to say there isn't a role for government tax and spend: there is. It is arbitrary confiscation that is damaging.

Socialists need to understand the full set of costs of expropriation and then explain how their remedies overcome this.

[Joe Merchant]

Re: Socialists suck (above)

One thing the socialists really miss the point on is this: People don't like to be have their chain jerked more than they are used to. The rich and powerful of the world are used to getting their way, and if someone proposes a new 10% higher tax on their income, they get pissed - I think there's a scene about this with a banker in Scarface. Now, the billionares of the world aren't quite all Tony Montana, but they are powerful, and they are used to getting their way, and they will do what it takes to scratch their itches.

When socialism was instituted in China and the Soviet Union, it did not eliminate highly powerful people, it created them - this concentration of power can be seen behind many of the problems they experienced. The billionares of the world are only weakly controled by economic forces, they don't build $20M 10,000 square foot homes because they will bring good resale value, they do it because they want to. I can already hear arguments that that the $20M isn't wasted, it's paid out in wages, materials, and even the development of natural resources - sure, that's true. And it doen't hurt society too badly, until we're all employed satisfying the whims of the elite.

In the end, "let the market forces decide" garners most of its power from de-centralization of decision making, from one person to many - almost sounds like a socalist ideal? It should. Neither system, socialism nor capitalism is perfect - they both have the flaw that money/power can be cornered by a few individuals, who then make decisions that may harm the majority, and even themselves.

So, what's the big deal about a little price gouging? When it totals over $100 billion in a quarter of a year, it's conspicuous concentration of wealth, it's not only offensive on a visceral level, it's a power shift as significant as one (small) nation conquering another. Arguably, Hitler was given too long a leash, and he ran with it. We shouldn't make the same mistake with major corporate entities or industry cartels. Jerk their chain before it gets really ugly.

As I said in a previous post, if gas prices are any indication, the industry is in appeasment mode. And if you think that inter-corporate competition is driving prices down, check _next_ quarter's profit statements. Prices haven't come down that far yet.

[Matt]

Joe,

It matters not a fig whether new taxes annoy the rich, or that they can afford them. It does matter for what that means to the security of property. You cannot arbitrarily walk over the rights of investors without expecting serious consequences for the economy.

Your core objection is that somebody made a buck. You do not recognize that occasional profits are necessary to offset occasional losses. You don't realize that when firms suffer losses and never do better than average they exit. You don't understand that short run profits can occur in dynamic markets, or that sustained profits cause entry.

Check out http://www.taxfoundation.org/publications/show/1139.html. Two things to note. 1) Oil profits vary tremendously (so much for being above economic forces - or is the chaos at ground level?) 2) Since 1977 the industry has paid $2 tax for every $1 of profit.

[Joe Merchant]

I'm not impressed with posted tax to profit ratios, the oil and gas industry employs a large number of fat and happy people, granting them generous benefits, perks, retirement packages, and some obscenely huge salaries, these are all charged against "profit" - at the same time, they employ an army of joe-six-packs and "contractor" workers (read: contractor=Mexican immigrant, usually illegal) who are out on the front lines, getting the dirty and dangerous work done for what amounts to barely a living wage.

So, my core objection is that after about 25% of that $26B additional revenue goes into profit taxes, another 12% of it will be posted in profits, and the rest of it will find its way into bonuses, pay increases, capital acquisitions, etc. This is the way of business, but in an industry like oil and gas, the bulk of those pay increases will go to the few people who make the decisions (surprise), capital acquisitions will include business essentials like a new Gulfstream G5, and a healthy chunk will go into "educating our lawmakers..."

My core objection is that these guys (and others like them) need to be taken down a notch or two, and if this windfall is blatant enough to wake up voting-joe-six-pack when he realizes that he paid an extra $2000 to the fat-cats this year - getting nothing in return and for no good reason other than to fund their otherworldly lifestyles, maybe he can find a political representative with the moral fortitude to do something about it.

That's intentionally overstating the case somewhat, but the voting electorate doesn't often make decisions based on actual data, research or learned analysis, they usually go with what they feel.

So - after the evil empires of the world have been broken - is scarcity driven price increase a good thing? Probably so, helps to incentivize needed resource capacity, etc. And, if the people of this country have nothing better to do than stand in line for gas, we really are an unproductive lot.

But - political change isn't about economic truths - it's about what people feel. And if you take a look at today's political landscape and Energy's place in it, it's time for a change. Energy is too close to the center of power for it to run efficiently, the decision makers in the big Energy firms have no incentive to not take huge personal profits. If enough people feel that it's gone too far, they might be able to alter the political landscape for the better.

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