Salinger on Price Gouging

Josh Wright —  26 June 2006

Economist Michael Salinger, Director of the Federal Trade Commission’s Bureau of Economics for the past year, comments on the recent FTC Report and price gouging in Sunday’s WSJ (HT: Greg Mankiw). I have blogged a bit about the FTC Report previously: once about its findings (that “market manipulation” did not explain post-Katrina price increases), once about media reactions to the Report, and again criticizing the ill-advised proposed federal price gouging legislation.

Salinger agrees that federal price gouging legislation is ill-advised (pay particular attention to the last line):

If the public were to ask my advice on the wisdom of price gouging legislation, however, I would counsel against it. When disasters like Katrina and Rita occur, prices must go up.

The difficulty is that without knowing the details of a disaster, it is impossible to specify in advance how much prices need to rise. As result, price-gouging legislation — particularly if penalties are severe and enforcement is aggressive — will pose two distinct risks. One is that prices will not rise to market-clearing levels and gas stations will run out of gasoline. As unpleasant as high-priced gasoline is, running out will be even worse.

The other is that gas stations will shut down rather than risk an allegation of price gouging. In the wake of major market disruptions, it is always going to be possible in hindsight to identify companies that raised the price the most and to label them as “gougers.” But gasoline stations do not set prices in hindsight. A vague definition of price gouging will make it difficult for gas station owners to know what price they can charge and stay within the law. Indeed, the FTC investigation uncovered examples of gas stations that shut down rather than risk a suit under a state price-gouging statute.

Salinger is also on to something when he suggests that economics professors at both colleges and high schools should teach portions of the FTC Report to students because it provides a real world example of how markets respond to shocks:

Students will benefit from discussing whether the evidence is more consistent with the chapters on perfect competition, monopoly or oligopoly. They will also benefit from discussing the wisdom of government intervention in the marketplace. (I even have a recommended exam question. “Oil industry critics argue that lower inventory holdings have left the industry more susceptible to supply disruptions. How would ‘price gouging’ legislation affect the incentive to hold additional inventories to sell during shortages?”)

It appears that despite the fact that economists just about universally agree that such legislation is a bad idea, some form of it will eventually pass. While a consensus among professional economists may not win the day in the politically and emotionally charged policy debate over price gouging, perhaps increasing knowledge of basic economic principles at the high school level and beyond may ultimately prove the best available means of slowing this urge to “do something” about gas prices without giving serious thought to the inevitable consequences.