Price Gouging and History

Introduction

It’s hurricane season, and a topic which was widely debated during Katrina is back again for Irma and Harvey – price gouging.

As usual, some may argue that anti-price gouging laws are needed so that individuals would not “exploit” others. However, as an economics argument (as in general), this falls short. Economists do agree with price gouging, that price gouging – in the long term – would not hold.

However, rather than just arguing in theory on why we shouldn’t have price gouging laws, we should look from an economic history perspective on price gouging, and compare with today’s anti-price gouging laws.

I will take historical data from California’s gold rush, specifically in San Francisco, and compare it with Hurricane Katrina. With this comparison, we look at how long it took San Francisco to recover from its early disasters, as well as how long it took to recover from Hurricane Katrina.

San Francisco Great Fires and Price Gouging

San Francisco, during its early days of the gold rush era, had numerous problems, specifically with fire.

The first few fires in San Francisco made people take great lengths to protect the city from further fires. The first of the fires started on December 24th, 1849, causing property destruction of $1 million ($32.4 million in 2016). Six months later, another fire broke out on May the 4th, 1850, destroying three blocks of the most valuable buildings in the town; the property damage of this fire was around $4 million ($127 million in 2016).

Unfortunately, this wasn’t the end of San Francisco’s fire disasters. In fact, after the 1850 fire, the town attempted to pass legislation:

An ordinance was passed immediately after this fire that any person who refused to assist in extinguishing the flames or to assist in removing goods should be fined no less than $5 nor more than $100.

Already with this quote we can see that after the first two fires, basic goods (or goods in general) were becoming scarce, due to fire damages. With the passing of fines of $5 to $100 ($159 to $3,170 in 2016), it would seem logical that fires would be reduced, or that property damage would also be reduced. However, just one month later, another fire broke out.

As a result, after the three fires, architecture styles changed, and incentives for more Firefighting companies came into existence.

The fourth great fire took place on September 17, 1850 destroying an estimated $250,000 of property ($7,930,000 in 2016), then another fire on October 31st, and December 14th resulting in another $1 million of property damage ($31.70 million in 2016).

Another fire, on May the 4th, 1851 broke out. However, this fire coincidentally took place on the anniversary of the second great fire (May the 4th, 1850), and this fire was worse than any of the previous ones.

The results of the fire sent flames throughout most of the streets in San Francisco. It was said that the flames could, “be seen a hundred miles from sea”.

The results of this disastrous ten-hour-long fire were 1,500 to 2,000 houses destroyed and property damage of $12 million ($389 million in 2016).

Not long after, on June the 22nd, another fire broke out resulting in a further $3 million of property damage ($97.20 million in 2016).

The result, after the many fires between 1849 and 1851, would be that price gouging would take place in practice.

With the quote mentioned earlier above, we can see that within that 2-year period, certain laws were passed in attempt to prevent further destruction of goods used by businesses, indicating shortages.

By using historical prices on bread, butter, tea, and bacon (considered essential foods and drinks for the gold rush mining era), I’ve created a weighted index, and measured the yearly change of the index.

Although technically no single year was considered a statistical outlier, the data itself speaks to the fact that, between 1849 and 1852, Inflation rates for basic goods reached beyond 30%, in 1849 reaching 60.77% and in 1852 reaching 48.95%.

This, by itself, shows that the damages done during the fires brought on some form of price gouging. What’s more remarkable is the fact that prices recovered extremely quickly.

Other data points, of inflation rates above 20% and below 30%, could be explained due to sudden population increases due to the gold rush, and/or other factors.

Considering that the 19th century had slower transportation and communication than our century, what was the story with Hurricane Katrina and the disaster it inflicted?

During Hurricane Katrina, federal communication breakdown occurred, FEMA was completely prepared for a different scenario (despite having advance knowledge of Hurricane Katrina and having simulations created for such a scenario). Furthermore, most equipment which should’ve been utilized by the National Guard was in Iraq. Thus, from the start, FEMA and the National Guard had a shortage of supplies.

During Katrina, anti-price gouging laws existed; as a result, people such as John Shepperson attempted to bring 19 generators to sell for double his purchase price in Mississippi.

In reality, who benefited from the confiscation of 19 generators and the arrest of John Shepperson?

First, we look from the consumer’s point of view.

With higher prices, not all consumers would be able to afford generators; however, the amount of utility derived from generators is greater. This is because the generator is fulfilling the basic needs of the consumer, which is to have electricity.

Now, assume the price of generators is forcibly low (such as the case with anti-price gouging laws); essentially, it would give incentives for consumers to purchase their generator and still have spare income for other items.

Therefore, the forced low price does not reflect the actual higher use of the good.

This as a result would cause a misallocation of resources, and inevitably, shortages.

If prices are allowed to rise, these prices would force consumers to focus and consume/spend on the goods which matter more (the inferior good, electricity/generator) rather than spend on other goods which are considered normal goods/ luxury goods.

The next factor is suppliers (sellers); if they are allowed to raise prices, this creates incentives for suppliers to enter the market, as profits can be earned. As a result, the supplies of generators/electricity would increase – as it makes sense for suppliers to capitalize on such profit making opportunity – which in the long run would bring the price back to equilibrium.

However, what if profits are artificially kept low, as happens with anti-price gouging laws?

Two occurrences will take place; the first being that suppliers will no longer induced to supply generators for those that want it, as revenues do not reflect the change in supply and demand. Secondly, black markets may potentially form.

With black markets, not all suppliers are willing to enter the market place due to the risk entailed (with risk comes higher opportunity costs), thus again, economic profits are no longer at the point as they should be, and therefore black markets by themselves wouldn’t have the ability to increase supplies at the rate needed for optimal recovery/clearance. This again results in shortages.

Conclusion

In conclusion, anti-price gouging laws – in both Historical, and economic theory terms – do not make sense.

Exploring San Francisco’s history shows that price gouging, when allowed to happen freely, bids down prices towards equilibrium (or near equilibrium conditions).
Exploring Hurricane Katrina, we see that anti-price gouging laws do not solve anything in the short term.

Comparing to San Francisco and its great fires, we see that San Francisco both in qualitative and quantitative data recovered quicker as prices are allowed to move freely during a disaster.

Consider the following, that San Francisco in the 1800s had a higher degree of inefficiency, Hurricane Katrina and the areas affected by it should’ve seen quicker recovery if prices had the ability to move freely. Therefore, we can conclude that in reality, anti-price gouging laws create economic inefficiency, and negative social consequences.

While price gouging can be seen as a market failure, this doesn’t necessarily mean that government solutions can alter market-failure, and as explored in this article, they often make the situation even worse.

This post was written by Baland Rabayah.

The views expressed here belong to the author and do not necessarily reflect our views and opinions.

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baland.rabayah@beinglibertarian.email'

Baland Rabayah

Baland Rabayah is a student of accounting and finance at Bangor University and is also pursuing a Graduate Diploma in Economics at the University of London. Baland holds a Diploma in Accounting and Finance from the Bahrain Institute of Banking and Finance. He plans to pursue to continue his studies by doing a master's in economic history and a PhD in Economics. Baland follows a mixture of Chicagoan and Austrian principles in economics, with his influences being Murray Rothbard, Ludwig von Mises, Friedrich Hayek, George Selgin, Lawrence H. White, Peter G. Klein, Ronald Coase, and Milton Friedman. He is currently part of the Being Libertarian Merchandise Project’s management, and runs his own investments. Baland is also the former CEO of MoreTech Bahrain, a start-up company which attempted to launch Bahrain's and the Middle East's first flagship smartphone. He is a racing enthusiast, and regularly races professionally in Bahrain's SWS races.

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