The Hidden Costs of Price-Gouging Bans

As Hurricane Sandy attacked the northeast coast, I was disappointed to learn that New Jersey governor Chris Christie was signaling strong enforcement of his state’s price-gouging restrictions. Maybe the Republican politician is more interested in populist appeals to his citizens than actually helping them with some limited government, or maybe he just doesn’t understand economics.

Matt Yglesias explains the basic forces fairly well. When demand spikes for something, the price should rise. On the surface, many people think this looks like greed. They assume the product is going to run out anyway, and the business is simply trying to jack up their profits. Sure, in the immediate short-run, this is what happens. But rising prices also provides two benefits to consumers. First, it makes the supplies last longer and for more people, as some people earlier in line might buy fewer batteries or gallons of gas than they would have under the old price. Second, and more importantly, it increases the incentive for that business and any other business or entrepreneur to find a way to supply that product to take advantage of those profits. In other words, it counters the assumption that the product is just going to run out.

In fact, this is exactly what happened with taxi service Uber in New York City. They raised rates after the storm hit and claimed that they saw a 50% increase in the supply of drivers willing to be out in those conditions. Unfortunately, they received a big PR backlash. If there’s one thing people seem to hate more than not being able to buy something, it’s being able to buy it but at a higher price than they’re used to paying; thus Christie’s populist price-gouging ban.

So I wasn’t at all surprised to read the stories that began emerging yesterday about gasoline shortages. Economics predicts that price ceilings create shortages, and voila, here they are. Ceilings actually enforce a vicious cycle that makes things worse; people that can find gas have an incentive to hoard as much of it as they can since they don’t know when they’ll be able to get more, and if the price isn’t allowed to rise, they have no incentive to limit their hoarding, which only exacerbates the shortage for everyone else. (Are those mile-long lines really more fun than higher prices?)

To be fair, the lack of electricity and damaged roads are big factors, and there might be temporary shortages even in a free-flowing market. Still, I can’t help but wonder what creative ways would have been found to deliver power and/or gas to stations if they had been allowed to charge what that gas was actually worth. After all, it doesn’t matter how cheap gas is if you can’t get any.