Monday, January 22, 2007

Price "Gouge" Me, Please!

During the hurricanes in Florida, it became common for local politicians to stress that "price gouging", i.e. raising the price of any commodity, would actually be prosecuted by the state. In fact, these proclamations do not just occur during so called disasters. Every time there is a spike in the price of gasoline, it is met by calls for investigations of the evil oil companies, allegations of conspiracies between gas station owners, and calls for taxes on the profits of Big Oil.

Like a children's story, whenever prices rise, whether a disaster is occurring or not, it's as if a bad witch is to blame and must be stopped by state intervention. All that is tolerable then is for someone (the good witch) somehow to insure that the prices of commodities decrease or that they stay the same relative to some arbitrary price point determined somehow by the local politicians.

This level of economic ignorance sounds comical but it is the basis for federal and state laws which prosecute and jail businessman. Furthermore, these laws lead to shortages during disasters and wreak as much or more havoc then the storms themselves. If you don't believe it, sit in a gas station line a mile long waiting for hours while a bouncer with a billy club roams the parking lot (yes, this really happened in Florida last year).

Let's examine the concept of price gouging more closely. Say a storm creates a temporary surge in demand for a commodity which all else equal would result in an increased price for the commodity. But, according to the opponents of price increases it is unfair for a property owner to raise his price during a storm and in fact such a price increase is not just a temporary inconvenience but constitutes gouging which apparently is criminally evil. Why?

First, gas station owners actually own the gas that they buy from refineries. It is their gas just as your TV is your TV and your microwave oven is your microwave oven. What if I showed up at your house and said that my TV doesn't work and I need to buy your TV from you right now. However, I add, you must sell it to me at a "fair" price or else the state will throw you in jail. What would your reaction be to this and how is this different in principle from the storm scenario?

The premise of price gouging laws is that private property literally does not exist. The premise of these laws is that property owners are mere stewards of the property to be commanded by the state to sell it at a price deemed fair by local politicians and lawyers in hindsight. If the state can command you to dispose of your property on terms under which you would not voluntarily agree then in what sense is this actual ownership of property?

So, what is a fair price according to these politicians? Right now, gas is $2.37 per gallon at the local station. A few years ago it was $1.20. Twenty years ago it was different. Why is the current price fair? What if I think the price should be 10 cents per gallon or free or should be the same as it was in 1958? So, let's say the storm is coming. Now what is a fair price? Should it be $2.37? What if 500 cars show up demanding gas? What if some people are willing to pay more so they don't have to line up?

The point is that there is no such thing as an arbitrarily fair price. The fair price is the price at which the gas station owner is voluntarily willing to sell his gas and which a buyer is voluntarily willing to pay. This actual fair price changes based on myriad factors which change from day to day, week to week, and year to year.

The reason the price right now is $2.37 is because all things considered it is the price that levels supply to demand which is the most fundamental economic law known to man. Let's say that right now a gas station owner began charging 10 cents per gallon. What would happen? There would be a line around the block probably for miles and people would be filling gas canisters to get as much as they could at the low price with the intention of storing it for future use. Very quickly, the gas station would be completely out of gas and he would put yellow tape around the pumps to signal that he is out (note to Florida residents: does this situation sound familiar?). Now, let's say he charges $50 per gallon. How many people would go to that gas station especially if the one next to it is charging $2.37?

So apparently, $2.37 is the perfect price since customers are willing to pay it and the owner is able to make a profit. So what is happening when the storm is coming and the state forces gas stations to not increase their price?

Effectively, it is equivalent to the situation above where the owner is charging 10 cents per gallon. When there is a major increase in demand due to the storm the price should no longer be $2.37 just as last year or 20 years ago the price was different due to differing demand and supply. If the state mandates that the gas station leave his price at $2.37 it is equivalent to the scenario where the state orders the station to charge 10 cents per gallon under normal conditions. Of course, this artificially low price resulting from government decree causes an artificial shortage which results in long lines, empty stations, and lack of incentives for more supplies.

Let's say that stations were allowed to charge whatever they want. What would happen? Well, in non-storms they charge whatever they want so it why wouldn't it look just like now except gas would be more expensive? In other words, the stations would charge more let's say $50 per gallon. People would then tend to buy less gas, i.e. they would ration their purchase in such a way to just buy what they need to get them out of town until they can get to a cheaper station. This would result in just enough gas for everybody with no lines and no bouncers with billy clubs. Furthermore, the high prices and therefore high profits would incentivize the gas station owners to work as hard as they could to get more supplies as soon as possible. This is called the profit motive and apparently it has worked pretty well during the last few million years.

The same thing has happened with roof repair where the state has "warned" against price gouging. So what is the result? Two years after the storms, blue tarps still appear on Florida homes and waiting lists are still months long to get your roof repaired.

As always, the moral is the practical. Protecting private property and freedom for individuals to trade their property is morally good and it is practical.

Finally, I'm sure all the people of Florida with holes in their roof will join me in saying: Thanks State for not allowing anyone to gouge me...

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