Economics and the mid-life crisis have much in common: Both dwell on foregone opportunities

C'est la vie; c'est la guerre; c'est la pomme de terre . . . . . . . . . . . . . email: jpalmer at uwo dot ca

. . . . . . . . . . .Richard Posner should be awarded the next Nobel Prize in Economics . . . . . . . . . . . .

Tuesday, March 08, 2005

What Is Wrong with Price-Gouging?

Another community in Ontario is undergoing a contaminated water crisis.

People in the southwest Ontario city of Stratford are being warned not to drink the tap water – or even wash themselves with it. Health officials issued the advisory at noon Monday after the city's water distribution system became contaminated by potentially dangerous chemicals. It's believed to have come from a spill of detergents and waxes at a car wash in the city, located about 45 kilometres northeast of London, Ont.

....The city is bringing water in by tanker and running stations to supply water to households.

The local television newscasts also showed people queuing up to buy bottled water at Stratford stores and being limited to one case of 24 bottles per purchaser.

Why don't stores raise the price of water in these situations? Economists ceaselessly point out that higher prices would make sure water gets to those people who value it most. They also point out that higher prices would induce more stores to stock more water for the future, just in case they might have the opportunity to charge high prices for their inventory. Tom Sowell sets out the case quite well. The indomitable Karen Selick did an even better job here.

If merchants alienate regular customers by appearing to take advantage of their temporary misfortune, they might well lose more profits in the long run than what they will make in the short run. This is why some businesses choose not to increase prices, preferring instead to simply sell out.

On the other hand, stores that increase prices and thereby manage to keep scarce items in stock might actually gain new customers as shoppers stray from their normal haunts seeking a place that hasn’t sold out. Like most other business decisions, it’s a judgment call.

So, if we all know that price-gouging promotes both short-run and long-run economic efficiency, what's the problem? I expect it has to do with jealousy and redistribution. Put crassly, the objection to price-gouging is, "You have it, and I want it, and I don't want to pay any more for it than I would have paid yesterday." And, to add to that, "Furthermore, I'm gonna lobby for laws so you have to sell it to me at yesterday's price."

As I have asked many times before: who is the least-cost bearer of the risk, in this case, of water contamination? Who should bear the inventory costs of providing insurance in the form of a large stock of bottled water? Or who should bear the transportation costs of shipping water in from nearby communities?

If we don't allow/encourage retailers to recoup these costs, they won't provide the services. Individuals will be expected to anticipate and insure against a host of unforeseen risks. Shortages will recur in all sorts of areas because prices are not allowed to rise. And gubmnts will be expected to intervene.
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