Price gouging

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Definition

The term price gouging is a morally loaded term without a precise meaning, but it typically refers to a seller sharply and significantly increasing prices for a good in the short term in anticipation of, or in response to, a substantial short-run increase in demand (i.e., an outward shift of the demand curve), typically due to an emergency, without (or disproportionate to) an increase in the cost of production.

Rationale for price gouging

Shift in market-clearing price

The simplest rationale for price gouging, and explanation for why, prime facie, it need not be inefficient, is in terms of the theory of the market-clearing price. When there is a outward shift (expansion) of the demand curve, the market-clearing price increases:

Demandexpansionandmarketprice.png

In the short run, a dramatic outward shift of the demand curve can lead to a significant increase in the market price, because the short-run supply curve is highly price-inelastic. Over the longer run, the same expansion of demand may lead to a much smaller price increase, because the long-run supply curve is less steep (more price-elastic) because fixed costs can be reconfigured in the longer run leading to more flexibility.

More explicit rationale

As the expansion of demand curve picture makes clear, an expansion of the demand curve leads to a shortfall, where the quantity demanded exceeds the quantity supplied. This shortfall typically leads to some form of non-price competition (such as queueing) where buyers compete with each other to acquire the good, expending valuable resources that are not captured as gains by anybody, and where the good may not ultimately be acquired by the buyer who values it most. By raising the price, sellers avert shortfall in two ways:

  • They're able to induce themselves (or their factors of production) to produce more of the good, induced by the higher prices. In particular, even if there is a local shortage due to an emergency, a sufficiently high price can encourage sellers from nearby places to ship the commodity to the area.
  • They're able to induce buyers to cut back on their quantity demanded for the good. Those buyers who are less desperate for the good may thus choose not to buy the good.
A POWER BLACKOUT EXAMPLE: [SHOW MORE]

The main flip side

The flip side, or ignored aspect, of this rationale, lies with the wealth effect -- some people may be truly desperate for the good, but may be too poor or may lack the immediate cash to purchase it. Although wealth effects are operational in a number of situation, unanticipated emergencies are a particularly strong case.

It is, however, perhaps even more likely that in the absence of sellers increasing their prices, these poor or cash-strapped people would be unable to purchase the good, given that a general scarcity is more likely.

References

Weblog entries/articles