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The Real Cost of Anti-Price-Gouging Laws

As has happened before with many natural disasters, the COVID-19 panic is leading to complaints of shortages and “gouging,” which about two-thirds of US states have passed laws against (often in terms so vague that it makes any enforcement discretionary, and thus discriminatory). But rather than complaining of shortages and gouging, critics should realize that “gouging” is the solution to shortages, not a cost in addition to them. It is just raising prices when circumstances raise the value of the last (marginal) unit of a good available. And perhaps more important, but little noted, gouging may actually lower the costs to consumers of acquiring the goods relative to the effective price ceilings generated by gouging laws.

Consider the case of a gas station owner if people were lined up for blocks to get gas at his station. What cost are customers paying for gas? They are paying not just the dollar price charged at the pump, but also the opportunity cost of waiting in line (and there may have already been other costs, of searching, including unsuccessful searching, as well). But they bear the latter in a form that does not show up in official data on prices. Further, waiting in line, while costly, does not benefit the gas station owner.

A self-interested owner (not selfish, but simply desirous of advancing things he cares about, as are all of us) would not want that situation to continue. He would rather consumers bear costs in forms that also produce benefits for him. In other words, he would raise the dollar price, converting time “wasted” in line into revenue that benefits him. But when circumstances have raised the value of gasoline, such price increases can be called gouging, so the threat of prosecution holds prices artificially low, resulting in persistent shortages. In a nutshell, that is why when we see shortages that persist over time we know to blame the government, not the market. Only the government has the coercive power to stop owners from advancing their own interests by raising prices when the supply and demand situation warrants it, without violating anyone else’s rights.

In addition, given that the rationale for antigouging laws is to benefit consumers, we ought to check whether consumers are actually made better off. But consumers will likely be worse off as a result of antigouging laws.

You can see this easily in a supply and demand diagram. Start at the intersection of the two curves (where the red and blue lines meet). This is the quantity toward which market prices would tend. As economics professors have explained for years, that is because at that price the quantity that buyers want to buy matches the quantity that sellers want to sell. At any other price, either buyers or sellers will be frustrated by the inability to exchange the quantity they wish to, which will create a competitive process moving the price toward that equilibrium level.

In the case of an effective price ceiling below the market level (the solid green line), sellers are willing to sell less than they would at the higher equilibrium price (the quantity where the solid green line crosses the red line). Consequently, there will be less sold (though price ceiling backers like to imply that because buyers will want to buy more at the lower price it means that they will be able to buy more, even though they will be unable to buy more than the reduced amount sellers that are willing to sell). But if the quantity produced is reduced because sellers are not willing to produce as much, what would competition among the buyers lead to? Unable to compete in terms of higher legal prices paid, they would compete in other forms until total costs have risen above the supposedly unfair “gouging” price at the new “equilibrium.”

Supply and demand diagram

Supply and demand diagram

- Click to enlarge

That is, buyers’ total cost of prices paid plus the added costs borne by competing in other forms would rise, up to the height of the demand curve at the now smaller quantity produced. Holding the dollar cost down makes the total opportunity cost to buyers rise. And that does not benefit consumers as a group. It is only because those other costs aren’t as visible as prices officially paid that people don’t realize it.

There is an exception for those who are guaranteed the ability to buy at the controlled price. In many cases, such as wartime price controls, that party is government. But it is also true of existing renters—assured of the ability to stay in their apartments—under rent controls. Such consumers don’t have to bear the search costs of finding an apartment or maneuvering around the controls with under the table payments, tie-in sales of related goods at higher prices (e.g., having to also rent furniture or parking spaces from the landlord to rent an apartment), or other costly forms of competition, explaining why such controls are popular with those who don’t have to bear the added costs but unpopular with those who do.

It may be that people don’t recognize that gouging laws are likely to increase the costs to consumers, and harm rather than help them, because they are considering a false tradeoff. If they have already successfully located some of an item being held down in price, of course they would rather pay less for it rather than more. But that does not imply that they would be equally likely to find the item once its price were artificially held down. And it is the decreased likelihood of successful search (because although market prices generally reveal the price at which you can find a unit of a good, price ceilings reveal something far less valuable—prices at which you often cannot find a unit of the good) that triggers the competition, which increases the nonprice costs of the good in question. And when those other costs (including the costs of an unsuccessful search that many bear) are included, consumer costs have risen.

When circumstances have changed rapidly, such as in our current crisis, allowing market prices to change simply reflects those very different circumstances, aligning information and incentives for market participants. Price controls and antigouging laws just pretend that reality away. Yet many people support them anyway, because they believe they would benefit from suppressed prices for what they want. However, if people realized that such laws actually harm them as consumers—once all the costs they must bear are considered—perhaps we could put an end to this counterproductive way in which politicians prove that “I’m from the government, and I’m here to help,” which Ronald Reagan once called “the nine most terrifying words in the English language.”

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Gary Galles
Gary M. Galles is a professor of economics at Pepperdine University. He is the author of The Apostle of Peace: The Radical Mind of Leonard Read.
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