The economic benefits of price gouging

Texas Senator Ted Cruz recently caused some outrage when, after a winter storm left millions of Texans in the cold and without power, he flew to Cancun on a family trip. Barraged by criticism, he immediately returned to Texas and went to work by, among other activities, issuing a tweet to decry the “injustice” of increased energy prices amidst the disaster and calling for regulators to step in, presumably by controlling prices.

Other local politicians similarly condemned sellers who increased prices of food, water, and other supplies, and encouraged residents to report anyone breaking the state's laws against price gouging.

While flying to Cancun as constituents freeze in the dark is unseemly, it is also relatively benign. Meanwhile, government regulation of prices does actual harm. The United States has a long history of price controls, with uniformly deleterious consequences. For example, during the 1970s oil crisis, the government set maximum prices on gasoline, which created significant shortages. As documented in The Concise Encyclopedia of Economics, drivers endured long lines at gas stations, “receiving in the process a taste of life in the Soviet Union.”

The gas price controls made sellers worse off; they received a lower price. Buyers were also harmed. After accounting for the value of the time they spent waiting in gas station lines, the total cost to drivers was often higher than if there had been no price controls, and to make matters worse, they also had to pay higher taxes to pay for the approximately 20,000 Department of Energy employees engaged in controlling prices and other economic meddling.

Some might say that the circumstances of a natural disaster differ from those of the 1970s gas shortages. In a sense, they are right: in the aftermath of a disaster, resources are scarcer, which increases the imperative that they not be wasted through Soviet-style government distribution. The last thing you want after a natural disaster is a manmade economic disaster; unfortunately, politicians have a proclivity for delivering such additional disasters.

For instance, after Superstorm Sandy in November 2012, New York Governor Andrew Cuomo — today infamous for his calamitous and deadly mishandling of COVID-19 in the state's nursing homes — did even worse than imposing price ceilings by promising everyone 10 gallons of free gasoline. The result, foreseeable by anyone with common sense, but apparently unforeseen by Andrew Cuomo, was four-hour lineups at gas stations. And with gasoline distributed Soviet-style instead of through market prices, those who needed it most — emergency vehicles — were left without a sufficient supply.

The underlying economics in Texas's current situation are the same. The role of rising prices amidst scarcity is to ration demand of the scarce resource and encourage its supply. This seems lost on, among others, Texas Representative Joaquin Castro, who lamented price gouging at supermarkets while pointing to long lines and empty shelves. Ironically, if there were no anti-gouging laws and prices were allowed to rise, consumers would have a strong financial incentive to leave more on the shelves for those who need it most, and sellers would have a strong financial incentive to increase supply.

The case of home energy is a little different, since consumers don't see the bill until after the fact, meaning many could be unaware of the extent of the price increase when they consumed the energy. This weakens somewhat the ability of prices to efficiently ration demand, and also seems unfair to those who are charged significantly more than they were expecting to pay. But even here, having the government intervene with price controls would do more harm than good. The laws of supply and demand still apply.

Moreover, the sharp price increases to consumers were due to plans in which they bought access to wholesale prices for power, which in usual times are lower than retail prices but shot up when supply collapsed because of the storm. The price increase was unfortunate to be sure, but it is not feasible for suppliers to supply cheaper power when wholesale prices are low without charging significantly more when wholesale prices are high. Nor is it feasible for suppliers to forgive payments for those who object to the increased bill, since this would create a situation in which all of their customers are encouraged to demand that their payments be forgiven. These facts are not changed by stories of customers facing astronomically higher prices, such as several thousand dollars for less than a week of power.

Nobody likes paying higher prices, but they reflect the scarcity of resources, and scarcity inevitably creates trade-offs and unpleasant situations. Demand must be rationed either through market prices or government command-and-control. Time and again, market prices have proven better for society and less costly for consumers, when the costs are properly counted. Politicians, therefore, who wish to “help” by impeding markets, imposing price controls, and prosecuting price gougers, would do far less harm if they stopped trying to help. Maybe they could just go to Cancun instead.

HIGHER PRICES REFLECT THE SCARCITY OF RESOURCES.