Aug 312008

In the wake of Hurricane Faye there was this post at the Volokh Conspiracy criticizing Florida’s anti-gouging law. With Gustav bearing down on our shores it may remain timely, particularly because it’s the underlying thesis I wish to take issue with.

In the post Ilya Somin praised the “wisdom” of Glen Whitman in writing that anti-price gouging law may have the opposite effect to that intended. But I find myself questioning their assumptions.

He cites Whitman:

[H]igher prices induce suppliers to bring more of the scarce good – generators, batteries, flashlights, etc. – to market. Tyler [Cowen] responds by pointing out that, in the short run, the supply is fixed – but then he immediately offers the obvious counterpoint, which is that “in the long run the economy will stand readier with emergency flashlights.” Exactly so, and this seems to me a decisive argument. In order to stock generators and such, shop owners have to take up valuable shelf space that could have been used for other items. The added profit they can reap during times of crisis is the financial reward that compensates them for making sacrifices during ordinary periods. A policy that clamps down on “gouging” during a crisis makes it less likely that necessary items will be available during the next crisis. Also, . . . the higher prices attract suppliers in non-crisis regions to transport their goods to the region where they’re needed most. (Emphasis mine.)

Let’s say that it costs $1 to stock a flashlight, and that in normal market conditions the store can sell it for $2, making a dollar profit on each. But in a disaster, when there aren’t enough flashlights for sale, the store might be able to sell each for $10, thus making nine times as great a profit.

What Somin/Whitman are suggesting is that the promise of making a ready profit on any flashlights will motivate the store to stock more. But why? With a greater supply their potential profit will be less than it would be with a more limited one. If they can match supply and demand perfectly they’ll still only realize the same $1 profit (if not less, assuming they overstock for demand), but at nine times the shelf space. Why would any store want to do that?

I suppose the thinking is that stores would prefer to stock more flashlights that they are sure to move, rather than some goods whose demand is less clear. And that may be true: perhaps in hurricane season the store is likely to order more flashlights than non-hurricane purposed widgets. Of course, if in normal market conditions the store can generally made a profit on those widgets, the store must take a significant risk in reducing their supply of them, because what if the hurricane never hits? Then they will be stuck with too many flashlights, products that in greater supply will never be able to attract as great a profit as when their stocks were more minimal anyway, and not enough of the other widgets.

No, it seems clear that the store is better off not increasing its hurricane supplies. If it were to, it would stand to lose the profit on the non-hurricane widgets in favor of only a small profit on the hurricane supplies. Whereas if they were to stock as usual, they would risk no profit loss on the non-hurricane goods and stand to make a premium profit on the ones for whom demand has suddenly spiked.

Thus I just cannot see why anyone would believe that stores would voluntarily adjust their stocks without some sort of external pressure. If the profit on flashlights were forever limited to something close to its normal profit margin, then it would make much more economic sense to risk the shelf space. Stores would merely be gambling on the likelihood of flashlights being needed over non-hurricane widgets, and in hurricane season that may be a reasonable gamble. The risk-reward equation may make such a tradeoff worth it. But without that price control the risk would not be worth it, because in the absence of the regulation the store really would not have to risk anything in order to guarantee itself maximum profits.
Obviously in scenarios like these there are assumptions everywhere. But I see little reason why mine aren’t just as valid as theirs, or, moreover why theirs could be fairly assumed at all.

 Posted by at 3:43 pm

 Leave a Reply

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>