Say Anything Blog

An interesting analysis of so-called “price gouging” from an email to economist Greg Mankiw sent by a White House aide giving background on why the President will likely be vetoing the Federal Price Gouging Prevention Act should it reach his desk:

Congratulations! You are the proud owner of a new gas station in Boca Raton, Florida. You sell gasoline at this week’s average price in Florida: about $3.00 for a gallon of regular grade. Fun gas station owner fact: you make a pre-tax profit of only about 3 cents per gallon. (For comparison, taxes are in the range of 50 cents per gallon in Florida.) You make most of your profit from foot traffic in your convenience store, selling things like bottled water and soda, chips and candy, lottery tickets, and cigarettes. This means your profit motive drives you to focus first on keeping foot traffic coming into your convenience store.

Now a hurricane hits. Let’s say it takes out the power that supplies some fuel terminals, drastically reducing the gasoline flows that supply gas stations in South Florida.

Economists would call this a negative supply shock. The supply of gasoline in Florida has suddenly declined, and so the price you will have to pay to buy gasoline for your station is jumping by, say, $1 per gallon. Also, you now have serious concerns about getting your tanks refilled. In normal times, a supply truck might visit you once a week. Now it looks like it will be once every 10-12 days, and it’s unpredictable.

Should you raise your prices? Your cost of goods is about to jump by a third. Demand has spiked. Some people are driving to leave town and need to fill up. Others are afraid that gasoline will run out, and so they fill up just in case.

If you keep prices where they are, the increased demand will almost certainly cause you to run out of fuel before the truck shows up in 10-12 days. You’ll have to shut down, and you’ll have zero foot traffic in your convenience store (and therefore zero profits).

Or you can raise your price. If you raise your price, then some drivers won’t be able to afford it, and only those who value gas at, say, $4/gallon will buy. The reduced demand from the higher price will counterbalance the increased demand from the hurricane aftermath. You’ll sell fewer gallons each day, but you’re less likely to run out of gas 10 or 11 days from now. Your store will therefore remain open until the truck arrives to refill your tanks, and you’ll make profits from foot traffic in your store (even though drivers will be buying fewer chips and lottery tickets).

Now let’s assume that H.R. 1252, the bill recently passed by the House on a 284-141 vote, has become law. (Thankfully, it has not.) That bill includes the following language:

It shall be unlawful for any person to sell, at wholesale or at retail in an area during a period of an energy emergency, gasoline … at a price that –
(A) is unconscionably excessive;
and
(B) indicates the seller is taking unfair advantage of the circumstances related to an energy emergency to increase prices unreasonably.

Because of this (hypothetical) law, you have to worry that the Federal Trade Commission in Washington, DC, or the Florida State Attorney General (both of whom are given new enforcement powers) will decide that a $1 price increase is“unconscionably excessive,” or that your price increase is “unreasonable.”

You’re confident you could make a strong case that neither of those provisions hold, but what do you know? You’re a gas station owner, not an antitrust attorney. Let’s also assume that some local elected officials are on TV saying they are “on the lookout for price gougers,” and they are insisting that the Florida AG “use his authority to the fullest extent possible.” How are you to determine whether any of several officials, each of whom faces various bureaucratic, political, and public pressures, will decide that a 25 cent, 50 cent, or $1 price increase is “unconscionably excessive” or “unreasonable”?

If you make the wrong decision, you could pay a fine of up to $2 million, or go to prison for up to 10 years.

What do you do? Do you buy gasoline for $1 more per gallon, and raise your prices by the same amount, risking 10 years in prison? Of course not. You shut down until your supply price drops enough that you’re willing to take the risk. The “Federal Price Gouging Prevention Act” discourages you from selling gas when it’s needed most.

This is what happens when legislation is based more on emotion and a desire to pander than an actual consideration of the facts.

Read the whole thing.