Archives For price gouging

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.

I posted on the FTC Report findings earlier. In sum, the FTC was able to identify only isolated and sporadic incidences of pricing behavior which were not explained by changes in supply and demand conditions at the local, regional, and national level. In addition, the FTC investigation did not reveal any antitrust violations. The reactions to the FTC’s findings exhibit the expected variance from political pandering, to accusations that the FTC “whitewashed” its report, to boredom from economists (to whom terms like “price gouging” and “unconscionable prices” are foreign). Here are a few examples of what I was able to find in print:

  • “So we’re likelier to see Elvis than gouging on gasoline? That’s good news for everybody, isn’t it? Maybe we’ll keep an eye out, though.” Larry Neal, spokesperson for House Energy and Commerce Committee Chairman Joe Barton (Houston Chronicle).
  • “The Bush administration is uniquely handicapped when it comes to defending the public from price gouging because it doesn’t want to embarrass its friends in Big Oil. This administration’s high-prices-are-good-for-you energy policy depends on leaving Big Oil alone to charge whatever Big Oil has decided to charge.â€? Rep. Edward Markey (D-Malden) (Boston Herald)
  • “Our evidence and common sense suggest a vastly different picture of unconscionable profiteering by Big Oil. The FTC has barely found the tip of the iceberg,” Connecticut’s AG Richard Blumenthal (Washington Post).

  • “Asking the FTC to determine when firms have exercised market power is not likely to yield anything very definitive, and this study hasn’t. It’s not that they’ve concluded with certainty that firms have not exercised market power, only that that is no evidence of it. It is hard to distinguish in this industry between real scarcity and artificial scarcity created by the firms.” Severin Borenstein (Berkeley Economics) (Washington Post).

  • Barbara Boxer said the findings about the refinery “fly in the face of reality,” and that “[t]his report proves that this administration is owned and operated by big oil.” (SF Chronicle).

  • Greg Mankiw (check out his great blog) notes that neither the report findings, nor the reaction by politicians should be very surprising. See also Mankiw’s previous posts on price gouging here and here.

I find the accusations of industry capture thrown at the FTC disturbing. Apparently, these folks do not have any objections as to the merits of the report. Perhaps such objections are are forthcoming, but I’m not holding my breath. It should also be noted several states investigating post-hurricane pricing behavior also concluded that market forces were responsible for the price increases (see, e.g., n. 18 in FTC Commissioner Majoras’ testimony to the Senate which accompanied the report). The burden of proof logically must be placed on the parties arguing that “gouging,” however it is defined, is at the heart of price increases. The FTC report soundly, and strongly, rejects the notion that the burden has been satisfied to date.

The Federal Trade Commission was directed to investigate the possibility of price gouging and manipulation in the aftermath of Hurricane Katrina. The FTC released its 222 page report today (HT: Antitrust Review). It is a comprehensive analysis of local, regional, and national prices before and after Katrina and Rita. One of the key tasks charged to the FTC was the search for “gouging” and other anticompetitive practices.

I am still working through the Report, but my own reading is that it pretty clearly supports the conclusions that “gouging” does not explain any increase in prices during the relevant time period, that observable changes in supply conditions and other market trends do, and that federal (and implicitly, state) price gouging legislation is not a good idea. Here are some of the highlights from the press release:

  • In its investigation, the FTC found no instances of illegal market manipulation that led to higher prices during the relevant time periods but found 15 examples of pricing at the refining, wholesale, or retail level that fit the relevant legislation’s definition of evidence of ‘price gouging.’ Other factors such as regional or local market trends, however, appeared to explain these firms’ prices in nearly all cases.
  • The report reiterated the FTC’s position that federal gasoline price gouging legislation, in addition to being difficult to enforce, could cause more problems for consumers than it solves, and that competitive market forces should be allowed to determine the price of gasoline drivers pay at the pump.
  • No evidence to suggest that refiners manipulated prices through any means, including running their refineries below full productive capacity to restrict supply, altering their refinery output to produce less gasoline, or diverting gasoline from markets in the United States to less lucrative foreign markets. The evidence indicated that these firms produced as much gasoline as they economically could, using computer models to determine their most profitable slate of products.
  • No evidence to suggest that refinery expansion decisions over the past 20 years resulted from either unilateral or coordinated attempts to manipulate prices. Rather, the pace of capacity growth resulted from competitive market forces.
  • No evidence to suggest that petroleum pipeline companies made rate or expansion decisions in order to manipulate gasoline prices.
  • No evidence to suggest that oil companies reduced inventory to increase or manipulate prices or exacerbate the effects of price spikes generally, or due to hurricane-related supply disruptions in particular. Inventory levels have declined, but the decline represents a decades-long trend to lower costs that is consistent with other manufacturing industries. In setting inventory levels, companies try to plan for unexpected supply disruptions by examining supply needs from past disruptions.
  • No situations that might allow one firm – or a small collusive group – to manipulate gasoline futures prices by using storage assets to restrict gasoline movements into New York Harbor, the key delivery point for gasoline futures contracts.

These are not surprising findings. At least, they should not be (see my previous post here). Nonetheless, the FTC Report is a very welcome, and timely, substitution of analysis and evidence over handwaving in a debate that desperately needs it.

Via Ted Frank at Point of Law, the House has overwhelmingly passed a price gouging bill that will not help consumers, but on the bright side, is likely to provide a fresh example for microeconomics instructors teaching the consequences of price controls. The award for economic illiteracy of the week goes to the whole House, but special mention should be made for Joe Barton, Head of the House Energy and Commerce Committee, to whom the WSJ attributes the following words:

“We know price gouging when we see it. . . . We’re here to put the gougers out of business . . . or behind bars.”

Actually, I am hesitant to call Barton’s statement economic illiteracy because it is hard to fathom that anybody actually believes that they “know price gouging when we see it,” or for that matter, that the proposed bill will actually help consumers rather than simply create the impression that legislators are busy doing something to address the “problem.”

I am fond of Larry Ribstein’s concept of “criminalizing agency costs” (see, e.g., here), but what about imposing criminal sanctions for rationally responding to changes in supply conditions? While I am not creative enough to coin a new phrase, it seems obviously economically wrong-headed (much like the criminalization of agency costs) to use criminal sanctions to punish firm’s for increasing prices in response to a reduction in supply. Should firms collude in the wake of a natural disaster, the antitrust laws are plenty sufficient to punish this sort of behavior (see my previous comments here). There is simply no need for a federal price gouging law.

One more point. The text of the bill requires the Federal Trade Commission to define “price gouging” and gives enforcement powers to both state AGs and the FTC. This is particularly interesting in light of the FTC’s published statement regarding the wisdom of such laws. Here are a few highlights:

  • “If price gouging laws distort these market signals, markets may not function well and consumers will be worse off. Thus, under these circumstances, sound economic principles and jurisprudence suggest a seller’s independent decision to increase price is — and should be — outside the purview of the law.”
  • “Even if Congress outlaws price gouging, the law would be difficult to enforce fairly. The difficulty for station managers, as well as for enforcers, is knowing when the managers have raised price “too much,” as opposed to responding to reduced supply conditions.”
  • “The Commission remains persuaded that a federal price gouging law would unnecessarily hurt consumers.

So what possibly explains the adoption of these policies? Posner describes the phenomenon as follows:

“In times of catastrophe, with consumers hurting, the spectacle of sellers benefiting from consumers’ distress, while (it seems) deepening that distress by charging them high prices, is a source of profound resentment, and in a democratic society profound resentments trigger government intervention. Such intervention is nevertheless a profound mistake, and not only from some narrow “economic” perspective that disregards human suffering and distributive justice.”

This seems perfectly in line with Geoff’s comment to my earlier post on PGR’s observing that:

“PGRs are an example of a response to the irresistible force in politics to do something. That they are categorically condemned by people who know enough to condemn them (how’s that for tautology?) is really neither here nor there when the people want action. (Or am I being too cynical?)”

Of Prices and Price Gouging

Josh Wright —  18 January 2006

Price gouging regulations (PGRs) have been a popular topic of late in the blogosphere, particularly in the wake of increased post-Katrina (and Rita) gasoline prices. Becker and Posner make the now familiar economic case against PGRs here and here. The basic economic argument against PGRs is well tread ground which I will not repeat here. Suffice it to say, however, that the economic logic has not been sufficient to win the day with state legislatures for one reason or another. According to Federal Trade Commission Chairman Majoras’ Statement to Congress, at least 28 states currently have statutes that provide remedies for short term price spikes in the aftermath of a disaster. For example, Eliot Spitzer recently penned a new bill updating NY’s PGR to trigger upon a 25% markup rather than a “gross disparity” between cost and price. Some of the failure is for obvious reasons. As Chairman Majoras writes:

consumers are understandably upset when they face dramatic price increases within very short periods of time, especially during a disaster. But PGRs that have the effect of controlling prices likely will do consumers more harm than good.

But what is responsible for the disconnect between proponents of PGRs, who view such statutes as helping consumers, and the economists like Becker, Posner, and others (I include myself as an “other”), who view PGRs as harmful to consumers? Two arguments often raised in defense of PGRs (I realize there are others) on consumer welfare grounds are: (1) that they are “like antitrust laws,” and (2) that supply does not respond sufficiently to price signals during a disaster. Both are insufficient to justify PGRs for reasons I explain below the fold.

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