What is "Price Gouging"?

13 Apr 2006 in Regulatory Economics, Glossary

During and immediately after crises such as natural disasters, various parties will claim that someone is price gouging. What is price gouging, anyway? How do professional economists define it?

The answer is that there is no objective definition. Economists--who specialize in price theory and the behavior of markets and can study these things ad nauseum--have no definition for it, either. In fact, economists have avoided the term as if it were a social disease. A review of all the microeconomics textbooks on Neutral Source's bookshelf reveals that none have as much as an index entry. University of Chicago professor Steven Leviitt is co-author of Freakonomics and (presumably) the main content generator behind the eponymous blog. Freakonomics may be the all-time best-seller in economics, and it has proved to be immensely popular among non-economists who want to understand economic reasoning. Today it ranks #14 among Amazon.com books. Price gouging does not appear in the book, and appears only once in the Freakonomics blog--in a comment submitted by a reader.

A skeptic might retort that this illustrates the real-world irrelevance of economics. Neutral Source believes otherwise. Rather, the concept of price gouging is irrelevant to economics.

Wikipedia defines price gouging as:

a term of variable, but nearly always pejorative, meaning, referring to a seller's asking a price that is much higher than what is seen as 'fair' under the circumstances. In precise, legal usage, it is the name of a felony that obtains in some of the United States only 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 colloquial usage, it means simply that the speaker thinks the price too high, and it often degenerates into a term of demagoguery. Non-pejorative uses are generally in reaction to what the writer believes is an unjustified restraint on the market.

The key to this carefully parsed definition is that price gouging is defined by a buyer, generally after the fact, who is deeply unhappy that the price he willingly paid was much higher than the price he would have preferred to have paid. As the gap between actual and preferred prices rises, the buyer's sense of unfairness and anger towards the seller intensifies.

This asymmetry in perspective is critical. Sometimes buyers get the best of sellers and are able to secure unfathomably great deals. But in no such instance would a buyer be accused of price gouging. He would be credited as a savvy shopper. The gap between what the seller accepted and what he would have preferred to receive could be just as great, the seller's sense of unfairness and anger toward to buyer just as intense. These would not matter; the concept of price gouging is biased in favor of buyers and against sellers. Buried beneath the concept is a sense that buyers are entitled to have what sellers own without having to pay full price. Price gouging is thus not an economic phenomenon but a psychological one.

It's also a legal phenomenon. The State of Florida prohibits price gouging by law. According to Florida Attorney General Charlie Crist:

Florida Statute 501.160 states - It is unlawful during a state of emergency to sell, lease, offer to sell, or offer for lease commodities, dwelling units, or self-storage facilities for an amount that grossly exceed the average price for the commodity the thirty days before the declaration of the state of emergency or the seller price for the commodity the thirty days before the declaration of the state of emergency unless the seller can show increases in its prices or market trends justifying the price. Examples of necessary commodities are food, ice, gas, oil and lumber. This is a civil crime enforced by the Attorney General, the Department of Agriculture and Consumer Services and State Attorney.

Florida law forbids certain market transactions during emergencies but leaves its practical definition to post hoc prosecutorial discretion. Only prices that "grossly" exceed "average" prices that existed over certain arbitrary historical periods qualify, and there are no rules for defining either of these terms. The law covers "only" necessary commodities, but describes the concept of necessity broadly:

The Price Gouging statute covers only essential commodities. A "commodity" means any good, service, material, merchandise, supplies, equipment, resources, or other article of commerce, and includes, without limitation, food, water, ice, chemicals, petroleum products, and lumber necessary for consumption or use as a direct result of the emergency. Examples of non-essential items luxury items are alcoholic beverages and cigarettes. The law also requires those selling goods and services to possess an occupational license.

However dependent alcoholics and nicotine addicts might be, their cravings are deemed by law to be non-essential.

Other states have similar statutes, and these statutes are similarly vague. Texas prohibits sellers from charing prices that are deemed "exorbitant" or "excessive" during declared emergencies. As in Florida, these terms are defined by prosecutors after the fact based on a number of factors, but economic theory is clearly not one of them.

In a seemingly unrelated case, Levitt and Freakonomics co-author Stephen Dubner have inadvertently explained price gouging in economic terms. Los Angeles Times columnist Joel Stein wrote a piece April 11 on the sordid tale of New York Post gossip writer Jared Paul Stern's apparent attempt to extort $200,000 or more to refrain from writing scurrilous material about a particular billionaire. Stein recounts the conversations with Levitt and Dubner:

[Levitt] told me that, as I suspected, Stern's price was way off. "You can supposedly hire a hit man for $10,000," Levitt said. "Most reported cases of bribery and corruption are much less. Dan Rostenkowski was taken down for stamps and office furniture"...

"[Stern] probably could have gotten away with it if he'd been reasonable," agreed "Freakonomics" co-author Stephen Dubner. "But by asking for $200,000 from one payola victim, he's basically saying his services are worth a few million a year because he could easily try to shake down a dozen or two [dozen] people at the same time"...

Dubner thought Stern's big mistake was assuming that $200,000 meant nothing to a billionaire. Though being left alone might be worth the pocket change to Burkle, an economics law called the "disgust effect" shows that people will act against their own self-interest if they think they're getting ripped off.

In other words, Stern apparently was attempting to "price gouge" based on a perception of his target's ability to pay. But he chose to practice in a market for which any price greater than zero is grossly excessive or exorbitant, and he picked a target with a low threshold for disgust.

ECONOTRIVIA

Some markets (and some sellers) are more susceptible to charges of price gouging. A Google search performed today for "price gouging" and specific commodities that could be covered by Florida's and other states' laws produces a large but widely varying number of hits: gasoline (514,000), food (414,000), medicine (137,000), ice (120,000), drinking water (36,200), lumber (23,000), and hotel rooms (14,300).

But emergencies are not the only circumstances in which the charge of price gouging is leveled. Google searches yielded a significant number of hits for other goods and services traded in markets, including apartments (89,600), condoms (15,100), soft drinks (12,700), movie tickets (9,090), shampoo (906) and caviar (565).

Information quality caveat: Not all Google hits reflect a connection between the conduct described as price gouging and the item in question. However, the rank ordering of commodities by number of hits seems intuitively reasonable. The more price inelastic the short-term market demand is for the good or service, the more likely it is that sellers will be accused of price gouging.

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