Crisis economics: Price gouging laws perpetuate the hoarding of goods and create shortages

By Daniel J. Smith. He is Director of PERI, Jones College of Business, MTSU. 

"High prices in the wake of a disaster or in the face of uncertainty often spark consumer outrage and calls for stricter price-gouging laws. Such measures, however, would actually harm consumers searching for necessities in emergencies. 

After a disaster, such as the recent tornadoes in Middle Tennessee, or in the face of uncertainty, such as the coronavirus, it is instinctive for consumers to stock up on goods, such as water, toilet paper, and nonperishable food. Stores need some way to discourage consumers from hoarding or wasting necessities as well as to encourage the increased manufacture and delivery of necessities to the affected area. Higher prices, driven by the increase in demand for these goods, naturally incentivize both of these important functions. 

Higher prices encourage consumers to purchase what they actually need, leaving goods on the shelf for others. This discourages consumers from needlessly stockpiling goods. It also discourages consumers from putting these goods into lower-valued uses. For instance, $12 for a bag of ice will make the typical consumer think twice about buying that extra bag of ice to keep their beer cold, leaving more ice in the cooler for consumers who need it for more important uses, such as refrigerating baby milk or medicine. 

More importantly, the higher price encourages consumers outside of the affected area to also economize on their purchases. The increased demand for building materials for rebuilding New Orleans after Hurricane Katrina drove building material prices up across the nation, leading unaffected consumers to delay less essential building or remodeling projects. 

Purchase limits, while well intended, tend to be ineffective since consumers can readily get around these limitations by having multiple family members purchase goods or by splitting up their shopping into different trips or to different stores.

Higher prices also encourage the manufacture and delivery of necessities to the affected area. With a sudden increase in demand, it could take weeks for manufacturers to procure additional raw materials, increase production, and deliver needed items to areas affected by the unforeseen disaster.

It is expensive to ramp up short-term production in this fashion as workers need to be paid overtime, suppliers need to be incentivized to produce more raw materials, and operating machinery more intensively involves additional operating costs as well as wear and tear. 

Higher prices also encourage people to divert goods to the affected area where they are most needed the most. For example, they make it feasible for someone outside of the disaster area to purchase up necessities where they are amply available and rent a truck to deliver goods to the affected area. 

Ironically, higher market prices, by increasing the supply of necessary goods, is the driving force that will ultimately push the price back down. Price-gouging laws, which artificially keep the price of goods low despite their increased demand, tend to generate shortages by failing to discourage hoarding and by failing to provide the increased revenue necessary for manufacturers to temporarily ramp up production of necessary goods. 

Especially with a disaster, however, there is always concern for providing for low-income residents. But the empty shelves created by price gouging laws do little to help them. Low-income residents affected by disasters would be much better off if we allowed the price system to operate and instead focused on providing charity assistance directly to them."