Thursday, November 3, 2016

Dear LA Times reporter: Your lack of understanding of economics doesn’t mean that ‘price-gouging’ is a bad thing

From Mark Perry.
"Harvard economics professor Greg Mankiw recently defended “ticket scalping” in his New York Times op-ed “I Paid $2,500 for a ‘Hamilton’ Ticket. I’m Happy About It.” Professor Mankiw’s defense of an active secondary ticket market at prices above face value was summarized as follows:
It was only because the tickets prices were so high that I was able to buy tickets [to the Broadway smash hit play “Hamilton”] at all on such short notice. If legal restrictions or moral sanctions had forced prices to remain close to face value, it is likely that no tickets would have been available by the time my family got around to planning its trip to New York City.
In a response to Dr. Mankiw, Los Angeles Times reporter Michael Hiltzik revealed the limitations of his understanding of economic principles and basic price theory in an article titled “Dear Harvard prof: Your $2,500 ticket for ‘Hamilton’ doesn’t mean price-gouging is a good thing.” According to economics novice Hiltzik, economics expert Mankiw “doesn’t recognize that it’s one thing to countenance whatever the market will bear when you’re talking about a luxury such as a Broadway ticket, and quite another when you’re talking about staples or public safety [in an emergency].”
Well, no, that’s an elementary and amateurish mistake. Just like natural disasters don’t change the fundamental laws of physics, gravity or aerodynamics, those disasters also don’t change the basic laws of supply and demand. Hiltzik is recycling a frequent but hollow claim that the laws of economics should be suspended, ignored or circumvented following a natural disaster, which then motivates laws against “price-gouging.” But you can make a stronger case that it’s during the period following a natural disaster when we want market forces operating as forcefully and powerfully as possible. Reason? It’s the period immediately following a disaster when efficient resource allocation and addressing scarcity become more heightened than during a normal, non-disaster period. Disasters typically create huge economic disruptions that usually make certain critical goods much scarcer (water, plywood, generators, chain saws, hotel rooms, etc.) than before. To address those serious economic disruptions and disaster-related shortages, we only have two basic choices: a) market prices that accurately reflect true scarcity and market fundamentals, or b) price controls that ignore scarcity and market forces and transmit false information about scarcity. As cruel as it may sound to those who are long on indignation and short on economics like Hiltzik, market forces and market prices will address the post-disaster shortages more quickly and more effectively than government-determined, non-market based prices.

Hiltzik demonstrates more of his economic illiteracy with this feeble attempt to “school” Dr. Mankiw about government price controls:
Price-gouging in an emergency doesn’t look like a case of the market working efficiently so much as one in which the market fails. In other words, it’s crying out for government regulation. Getting products into a crisis zone can be more expensive than normal, so higher prices might sometimes be warranted. But that can be accommodated by anti-gouging laws that allow some flexibility — restricting price increases to 10% or so, or requiring a showing that higher production or transport costs justifies a higher price. But allowing suppliers to raise prices sky-high just because they can get them serves no one except the profiteers.
Here’s some further economic schooling for Mr. Hiltzik about government price controls following natural disasters, taken from Chapter 4 (in the section on “The Economics of Price Controls”) of Professor James Gwartney’s Principles of Economics textbook (15th edition, highly recommended remedial reading for Mr. Hiltzik and others unfamiliar with Professor Mankiw’s economic reasoning on this topic), emphasis added:
It is a natural reaction [for Mr. Hiltzik and others] to think that the higher prices are unfair and that price controls should be imposed [following natural disasters] to prevent “price gouging.” State and local officials have often imposed price controls for precisely these reasons. After Hurricane Hugo, the mayor of Charleston signed emergency legislation making it a crime to sell goods in the city at prices higher than their pre-hurricane levels. Similarly, Mississippi’s attorney general announced a crackdown on price gouging after Hurricane Katrina and after Hurricane Sandy, Governor Chris Christie’s administration filed lawsuits alleging price gouging against more than 70 businesses, including hotels and gas stations that had raised prices; convictions are punishable by fines of $20,000 per transaction.
While price ceilings may be motivated by a desire to help consumers by keeping prices low, they exert secondary effects that retard the recovery process. At the lower mandated prices, consumer demand quickly outstrips the available supplies creating artificial shortages. The controls also slow the flow of goods into the area. Shipments that do arrive are greeted by long lines of consumers, many of whom end up without anything after waiting for hours.
The price controls result in serious misallocation of resources. Electric generators provide one of the best examples. The lack of electric power after a hurricane means that gasoline pumps, refrigerators, cash registers, ATMs, and other electrical equipment do not work. Grocery stores can’t open and thousands of dollars’ worth of food spoils. Although gas stations have gasoline in their underground storage tanks, it can’t be pumped out. ATMs and banks can’t operate without electricity, so people can’t get to their money, which is critical because almost all transactions in post-hurricane environments are made with cash.
Hardware stores that sell gasoline-powered electric generators typically have only a few in stock, but after a hurricane suddenly hundreds of businesses and residents want to buy them. In the absence of price controls, the price of these generators would rise and individual homeowners would generally be outbid by businesses, which can put the generators to use operating stores, gas stations, and ATMs. It is these uses that would yield enough revenue to cover the high price of the generators because they facilitate the provision of other goods and services that people desperately want. Given the large sums such businesses would be willing to pay, some with generators at home would even find it attractive to sell or lease them to buyers willing to pay attractive prices.
Market prices would allocate generators and other urgently needed supplies to those most willing to pay for them. Price ceilings keep this from happening. In the absence of price rationing people keep their generators at home, and it is commonplace for hardware store owners with a few generators on hand to take one home for their family and then sell the others to their close friends, neighbors, and relatives to run televisions and hair dryers. Moreover, the incentive of people to take action and bring generators in from other areas is slowed.
For example, John Shepperson of Kentucky and his family took time away from his normal job to buy 19 generators, rent a truck, and drive it 600 miles to the Katrina-damaged area of Mississippi. He thought he would be able to sell the generators at high enough prices to cover his cost and earn a profit. Instead his generators were confiscated, Shepperson was arrested for price gouging, held by police for four days, and the generators kept in police custody. They never made it to consumers with urgent needs who desperately wanted to buy them.
The dramatic change in conditions that often accompany a hurricane highlights the role prices play. It also illustrates how the secondary effects accompanying price controls can magnify the damage generated by hurricanes.
According to Hiltzik, “Mankiw’s win-win transaction was actually a lose-lose for everyone except the scalper.” In the case of Shepperson and the 19 generators he brought to sell to willing buyers in Mississippi, we can see that it was price gouging laws that guaranteed a lose-lose situation for everybody involved. The local residents and businesses lost because they were unable to purchase one of Mr. Shepperson’s 19 desperately needed generators in a voluntary transaction at a mutually agreeable price. Mr. Shepperson lost because his generators were confiscated and he was locked up in a cage for four days. Local residents lost even more because the efforts of law enforcement agencies were diverted to arresting and booking Mr. Shepperson for price-gouging instead of spending that time to help affected hurricane victims. So who gained by the arrest and jailing of Mr. Shepperson, and the confiscation of his valuable and much-needed generators? Well, nobody! So instead of a win-win outcome for Mr. Shepperson and his willing and satisfied buyers in voluntary win-win market transactions, it was the price-gouging laws that resulted in a lose-lose outcome for all of the parties affected.

Bottom Line: To those untrained and unschooled in basic economic theory and principles it might be easy to have one’s thinking distorted by emotion and side-tracked into a world divorced from economic reason, logic reality and basic price theory. But once equipped with even the most basic and elementary economic principles that one can learn from Professor Mankiw’s or Professor Gwartney’s principles of economics textbooks (or classes), it should be easy to understand that government price controls (rent control laws, minimum wage laws, ticket scalping laws, and price gouging laws) do a lot more harm than good. While market prices will always maximize the number of win-win transactions, government price controls like price-gouging laws are guaranteed to maximize the number of lose-lose outcomes – mostly from transactions that never take place, like the generators in the example above that never reached the affected area in Mississippi and the desperate residents willing to buy them.

Summary Score on Ticket Scalping/Price Gouging: Greg Mankiw, Ph.D. (MIT), Robert M. Beren Professor of Economics at Harvard University, and the Best-Selling Author of Several Principles of Economics Texbooks 1, LA Times Columnist Michael Hiltzik 0.

Related: See Don Boudreaux’s response to Hiltzik on Cafe Hayek in a blog post titled “The Price Is Right (Even When It Isn’t Agreeable).“"

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