Price Gouging is a Good Thing

With no end in sight for the coronavirus panic, there's still a shortage of basic items like toilet paper, hand sanitizer, and other items that people have started hoarding. A few people were caught jacking their prices sky high on Amazon, and were quickly removed. After all, price gouging is unethical and harmful, right? Wrong. Price gouging is a very good thing. 

Price Gouging

Wikipedia describes price gouging as the practice of increasing the "prices of goods, services or commodities to a level much higher than is considered reasonable or fair."

Similar definitions can be found elsewhere, and usually price gouging is deemed to be the increasing of prices to an unethical level. However, "fairness" is often very subjective, and humans are often very selective in what they consider fair. And that issue is really the crux of the matter. What appears fair to the consumer might seem wholly unreasonable to the supplier, and vise versa. Similarly, one consumer might consider something fair, while another might consider it quite unfair. 

Supply, Demand, and Price Ceilings

One of the most objective ways of defining fairness is through the laws of supply and demand. Most people have at least some familiarity with the concepts of supply and demand. There are two separate laws, the law of supply and the law of demand, which interact with one another to determine the "appropriate" price in a market. This appropriate price is called the equilibrium price or the market clearing price, because it's the price where quantity consumed is equal to quantity supplied. Such a price can objectively be considered fair. However, if supply is greater than quantity demanded, there's a surplus, and if it's less than quantity demanded, there's a shortage. 

While pricing isn't perfect, in a natural environment, prices tend towards this market clearing price, as it is an efficient and ethical price. Items are not wasted as they sit on shelves, and the people who want an item are able to get it. However, government often steps in to manipulate the situation, as is the case with price ceilings and anti price gouging laws.

When demand increases, the demand curve is shifted to the right, as indicated in this graph (Paweł Zdziarski (faxe), Astarot CC-BY-SA 3.0). 

Quantity demanded increases, and the price increases accordingly. This dynamic is natural, and acceptable. However laws often prevent it. The next graph gives a much more detailed analysis of price and consumption dynamics, and includes a price ceiling (Wikipedia: CC-BY-2.5).

The price ceiling is below the market clearing price, so there's an excess of demand. This dynamic leads to shortages, exactly like we've seen occur. Now, one might say that price gouging is often above the market clearing price. And they'd be right, at least in the short term. That's because suppliers themselves cannot keep up with the increased demand. So prices overshoot. This overshooting reduces the quantity consumed, while temporarily increasing the per unit profit.

But those profits do not just go into the pockets in the suppliers. Image from Wikipedia (CC-BY-SA 3.0). They are transferred to the producers who can then ramp up supply. This dynamic results in a shifting of the supply curve to the right, which shifts the new equilibrium price lower, even at a higher consumption rate!

It is for this reason that the market is largely self regulating. Prices, consumption, supply, and demand all work in harmony, and tend towards efficiency and access, resulting in neither long term shortages or surplus. And while this system is not perfect, price controlled systems are even more imperfect.

Nonlinear Pricing

Most people are actually aware of nonlinear pricing, even if they don't know it by name. Nonlinear pricing is a pricing scheme where the price of an item changes depending on how many items are purchased. For instance, in a linear pricing scheme, an item might cost €2 each, so ten would cost €2 * 10 or €20. In a nonlinear pricing scheme, you might get a bulk discount and only pay €18 for the ten items, or €1.80 each, on average. Buy two, get one half off and similar promotions are examples of nonlinear pricing, as are all bulk discounting schemes.

Usually buying more of an item will cost you less. However, it might not always be the case. While browsing a number of discussions on the topic, I came across a thread on Reddit about a supermarket in Denmark charging roughly €5.50 for a bottle of hand sanitizer, but buying a second one would cost €134.00

The question of price gouging can be posed. Is this action price gouging? Certainly the average price, if people buy more than one, is much higher than it was before. So prices are being increased in response to demand shock. Is it unfair? A lot of people would say no, because a person who really needs one bottle can still get it at a reasonable price, and if someone really wants another bottle, they can hand over the cash for it.

But what if you're buying for yourself and an elderly family member? What if one family can send out a whole hoard of siblings to each buy "one" bottle while another person lives alone? While in many ways linear pricing can be considered fairer, there are still always questions that remain. 

Price Gouging is Okay!

It is because of the ambiguity in the question of fairness, and because so called price gouging can allow for the significant ramping up of production, leading to a new set of supply and demand curves, that can satisfy demand without creating long term shortages or surplus, that I have no issue with the practice.

Additionally, it makes no sense that businesses would raise prices so much that people couldn't buy anything, as that would mean that businesses couldn't sell anything. Moreover, one reason why a few people have tried to ramp up prices so much is that a few people are likely to get away with it, while large suppliers are unable to reasonably increase their prices in response to increased demand. 

That being said, I do like the idea of incorporating some degree of nonlinear pricing into the model, so that at the very least someone who wishes to just buy a single item can do so at a lower price.