Price Gouging in America

Price gouging, as many politicians and ignorant social commentators claim, is a practice used by business companies to take advantage of consumers during times of distress or natural disaster. For example a swarm of termites was predicted to swarm a town in approximately one week, the raising of prices during the disaster by pest control companies would be viewed upon as price gouging due to them taking advantage of a crisis. Furthermore if the pest control companies were to raise prices before the termites even came it would be frowned upon and probably be condemned as an act of injustice to the people.

However if you know the basics of supply and demand you can look into the situation from a very different perspective. Pest control supplies and chemicals we know are a scarce resource and furthermore there is a price to storing extra quantities of this commodity. So companies reduce the amount of chemicals in storage to the most efficient amount needed in order to be able to minimize costs and compete more effectively against their competition. However, when a natural disaster occurs and there is a sharp increase in demand for a certain product and not enough supply, that town is going to see a lot of homes get severely damaged by the termites. But one tool that companies can use to control their supply is pricing. By raising prices a week before the termites come they are able to reduce the amount of pest control sold, therefore increasing their supply for when the natural disaster comes while simultaneously not incurring severe losses, then they are more effectively equipped to meet the demand of the consumers during the time of emergency, cushioning the damaging effects of the infestation.

This same scenario happened in real life when Hurricane Katrina was headed for the gulf coast. People saw gas prices rise even before the hurricane came, and they said that gas companies were taking advantage of the people. However, the gas companies were not taking advantage of anyone, they were simply using the most effective tool they had to control the amount of supply of their gasoline using the simple practice of supply and demand.

The gas companies were more equipped to help cushion the hard hit the hurricane dealt to the gasoline industry by increasing their supply before the disaster occurred. Some politicians want to outlaw the increase of prices or at least regulate it very harshly, crippling the gas companies ability to manage their pricing.

However some politicians still want to place pricing caps and outlaw the raising of prices before and after a natural disaster. If these were to take place we would see a serious lack of supply during natural disasters. For instance we would be experiencing shortages, long lines at gas stations, and all of this would be compounding upon the damage already inflicted by a natural disaster. That would mean companies would have to store enormous amounts of fuel in order to meet the demands of the people in case of a natural emergency which would in turn increase their costs of operation be insane amounts, a cost that eventually would be passed on to the consumer.

Many people still argue that the free market without any regulation might result in severe price gouging during times of emergency due to businesses colluding and agreeing on setting prices at unreasonable levels, however, that is disputed by economists such as Milton Friedman who maintain that due to competition and the ability of just one competitor to be able to seize nearly all of the market share during such a time of collusion, the profit incentive which is regarded as the very incentive to collude, is the very tool that keeps prices low and businesses constantly competing for market share.

For instance, if during hurricane Katrina, most of America's top oil companies were to collude and set an unreasonable price, they would be assuming an enormous risk, so enormous that if just one company were to cheat, the rest would lose incredible amounts of profit and market share, that they would be better off to have never colluded in the first place.

The simple tools of supply and demand can show you an entirely different perspective on business practices that were previously questionable to the uninformed, now make sense and are indeed beneficial to not only producers, but consumers as well.

Reference: John R. Lott Jr. Ph.D.