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Price gouging is a pejorative term referring to when a seller spikes the prices of goods, services or commodities to a level much higher than is considered reasonable or fair, and is considered exploitative, potentially to an unethical extent. Usually this event occurs after a demand or supply shock: common examples include price increases of basic necessities after hurricanes or other natural disasters. In precise, legal usage, it is the name of a crime that applies in some jurisdictions of the United States during civil emergencies. In less precise usage, it can refer either to prices obtained by practices inconsistent with a competitive free market, or to windfall profits. In the former Soviet Union, it was simply included under the single definition of speculation.
The term is similar to profiteering but can be distinguished by being short-term and localized, and by a restriction to essentials such as food, clothing, shelter, medicine and equipment needed to preserve life, limb and property. In jurisdictions where there is no such crime, the term may still be used to pressure firms to refrain from such behavior.
The term is not in widespread use in mainstream economic theory, but is sometimes used to refer to practices of a coercive monopoly which raises prices above the market rate that would otherwise prevail in a competitive environment. Alternatively, it may refer to suppliers' benefiting to excess from a short-term change in the demand curve.
As a criminal offense, Florida's "state of emergency" law is an example. Price gouging may be charged when a supplier of essential goods or services sharply raises the prices asked in anticipation of or during a civil emergency, or when it cancels or dishonors contracts in order to take advantage of an increase in prices related to such an emergency. The model case is a retailer who increases the price of existing stocks of milk and bread when a hurricane is imminent.
In Florida, it is a defense to show that the price increase mostly reflects increased costs, such as running an emergency generator, or hazard pay for workers, while California places a ten percent cap on any increases.
Laws against price gouging
In the United States, laws against price gouging have been held constitutional at the state level as a valid exercise of the police power to preserve order during an emergency, and may be combined with anti-hoarding measures. Exceptions are prescribed for price increases that can be justified in terms of increased cost of supply, transportation, demand or storage. Statutes generally give wide discretion not to prosecute: in 2004, Florida determined that one-third of complaints were unfounded, and a large fraction of the remainder was handled by consent decrees, rather than prosecution. As of 2008, laws against price-gouging have been enacted in 35 states. Price-gouging is often defined in terms of three criteria listed below:
- Period of emergency: The majority of laws apply only to price shifts during a time of disaster.
- Necessary items: Most laws apply exclusively to items which are essential to survival.
- Price ceilings: Laws limit the maximum price that can be charged for given goods.
Opposition to laws against price gouging
Economists Thomas Sowell and Walter E. Williams, among others, argue against laws that interfere with large or exorbitant price changes. According to this view, high prices can be viewed as information for use in determining the best allocation of scarce resources for which there are multiple uses. Many libertarian economists oppose price gouging legislation and argue that it prevents goods from going to individuals who value them the most and not just to those with the greatest wealth. For example, after a storm has felled numerous trees in a locality, advocates of this theory claim that a rise in the price of chain saws will discourage their purchase by people with only a minor need for them, making them more available for those with the strongest need, rather than the most wealth. Problems during the Siege of Paris (1870–1871), which critics attribute to price restrictions, are often held up as another example. With price gouging laws in place, producers are only able to charge a price set by law, and therefore have little additional incentive to increase supply to adversely impacted areas. If producers are able to make extra profit, these theorists argue, then they will increase the supply. It is claimed that these laws lead to after-market operations as consumers with the lowest opportunity costs buy up desired resources and attempt to resell them to public at higher prices.
Critics claim that laws against price-gouging could discourage businesses from proactively preparing for a disaster. One example given in support of this view is that a business could install an expensive emergency power system for power outages. However, if it is prohibited from large price increases, the costs cannot be recovered during the relatively short amount of time when there is no power. As a result, a business that proactively prepared could not compete with others that did not. (This is generally unnecessary for similar businesses in close proximity to one another.) According to this theory, the end result would be needless shortages and more hardship for the public, or under extreme circumstances, it could be deadly. To correct the situation, those opposed to price gouging laws argue that if not abolished entirely, laws would have to be amended to allow the amortization of equipment that is useful only during a disaster. Unlike amortizing for tax purposes, this would account for how equipment is sporadically paid off internally with the extra revenue.
In support of the argument against price-gouging legislation, some assert that a similar situation applies to those who are outside of the disaster zone and willing to go there to sell what is desperately needed. If they are unable to recover their travel costs and be compensated for the inconvenience of staying in an inhospitable disaster zone, only the altruistic few would bother to do so. Since most anti-price gouging laws are based on the pre-disaster selling price, a person who buys needed supplies at the retail level in an unaffected area will more easily run afoul of the law than a large wholesaler would. They assert that it would be the "little guy" who could lose more on a percentage basis, in addition to the possibility of hefty fines, rather than "big business."
Opponents of anti-price gouging laws also claim that in terms of fairness, such laws could also require producers to sell goods below their market-clearing price: the market clearing price is the amount at which quantity supplied is equal to quantity demanded. According to this theory, if goods are priced above their market-clearing price then there will be a surplus of goods, and the converse leads to a shortage of goods. Thus, advocates of this theory claim that consumers would be unable to buy the necessary goods which they desire in a time of need.
According to the theory of neoclassical economics, anti-price gouging laws prevent allocative efficiency. Allocative efficiency refers to when prices function properly, markets tend to allocate resources to their most valued uses. In turn those who value the good the most (and not just the wealthiest) will be willing to pay a higher price than those who do not value the good as much. According to Friedrich Hayek in The Use of Knowledge in Society, prices can act to coordinate the separate actions of different people as they seek to satisfy their desires.
- Hoarding (economics)
- Just price
- Price fixing
- Sherman Antitrust Act
- Unintended consequences
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- "State's anti-price-gouging law upheld". Business First of Louisville. October 6, 2009. Retrieved 2010-08-19.
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- M. Zwolinski (2008). "The Ethics of Price Gouging". Business Ethics Quarterly. 3: 347–378. SSRN 1099567.
- Hayek, Friedrich A., The Use of Knowledge in Society. 1945. Library of Economics and Liberty. 6 December 2010.
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