Comments on economics, mystery fiction, drama, and art.

Monday, December 24, 2007

Price gouging--a possible taxonomy

A few days ago, Phil Miller provided a link to Bill Polley's post on price gouging. Polley has written a very nice, conventional economist's take of the (non-existence) of price-gouging, starting from the developments in the last year in the market for hay in the midwest. Briefly, drought conditions in some parts of the plains led to significant decreases in supply and higher prices in some areas. Almost immediately, hay began to be shipped from areas in which there had not been drought conditions, seeking to take advantage of the higher prices (and, on the other hand, needing higher prices to afford the transportation costs). Polly notes that no one referred to this as "price gouging."

In general, economists are not sympathetic to allegations of "price gouging," pointing (in almost every case) to changes in demand conditions or in supply conditions that would lead, all but inevitably and certainly unsurprisingly, to higher prices. So why didn't the rising hay prices result in allegations of "price gouging"?

I would suggest that it's because people in general react differently to objectively different circumstances, and some of there trigger allegations of "price gouging," while the others don't. So let's see if we can provide a taxonomy of things that could happen.

1. Suppose a firm manages to monopolize an industry. It buys up its rivals, it makes it difficult for its customers to switch to another supplier. Let's call that firm TicketMaster. Once it's succeeded, it raises its charges and service fees. For example, the last time I bought concert tickets through TicketMaster (which dominates ticket sales for music venues in the Chicago area), the tickets "sold" for $29.50 each, but the added fees raised the overall charge per ticket to $47.50--the fees added more than 60% to the price of the tickets.

2. The state government raises the tax on cigarettes by $0.50 per pack, and the retail price of cigarettes rises by almost $0.50 per pack.

3. Because of the convenience of bottle water (and potentially because of some real or imaginary health concerns), the demand for bottled water increases. At least in the short-run, the price of bottled water rises.

4. Because of a hurricane, the local water supply system is put out of order. People are forced to rely on bottled water for drinking, cooking, etc. So the demand for bottled water increases. The price of bottled water rises.

In which of these four cases are people more likely to attribute the price increase to "price gouging"? I'd contend that it's only cases 1 and 4. In case 2, people will almost certainly attribute the increased price of cigarettes to the tax increase. (Or, as in the case of hay that Polley discusses, to the drought, which buyers of hay recognize as affecting the ability of farmers to produce hay.) In Case 3, people will tend to recognize that their increased desire for bottled water, which has occurred because the values of buyers have changed, underlie their willingness to pay higher prices, and they will tend not to attribute the higher prices to the actions of sellers.

In case 1, the price increases will be attributed to the greedy monopolist who has obtained the power to raise prices. In case 4, note that buyers do place higher value on bottled water than they used to, but it's because of an external force that they are responding to, not because they changed their "real" preferences. Also, I think it's important that the change is temporary rather than permanent. And also to note that the hurricane has put people under pressures in addition to that of the higher price for bottled water. So people tend to see the price increase as "taking advantage" of people who, at least temporarily, have no options, who have been forced to use bottled water rather than tap water. Even if there are additional costs of shipping the water into the affected region, people see this as an "unfair" response, in ways that the higher prices in cases 2 and 3 are not seen as unfair.

Which brings me to gasoline. To economists, the story is clear. Changes in the market for crude oil, whether temporary spikes in demand or long-run permanent changes in supply, have driven up crude oil prices, leading to higher costs of refining gasoline (and thus to reductions in the supply of gasoline). The all-but-inevitable outcome--higher prices. Yet many people see this as "price gouging."

Economists would say this is "more like" my case 2. Many people would, I think, see it as "more like" case 1, and thus see the price increases as "price gouging." Why the disparity?

I think it's a consequence of people seeing the production of gasoline as occurring in a vertically-integrated, highly-concentrated industry. BP pumps crude oil out of the ground, ships it to its own refineries, and sells it at retail in its own retail outlets (substitute Exxon/Mobil or Shell or...). So we have trouble seeing the increased price of crude oil as something that "happened to" the oil companies, and may find it easier to attribute it to something that oil companies have "decided to do." If we did see the crude oil price increase as exogenous to the oil companies, we would, I think, be less likely to see the increase in retail gasoline prices as "price gouging."

What we have here is a heuristic narrative that people use to understand the outcome (higher gasoline prices). And this narrative looks to many people as being more like my case 1, while economists see it as more like case 2. Who's right? Ah, that's a story for another day.


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