September 8, 2017

Stock You Like a Hurricane - When Price Gouging Won’t Fly under Severe Weather Conditions

In the wake of the devastation caused by Hurricane Harvey, many on the East Coast are watching closely to see where another powerful hurricane, Irma, will make landfall in the continental United States. These back-to-back catastrophes have created a unique situation in which many items considered necessities for surviving during and after such a storm are in short supply. In fact, in the wake of the devastation left by Harvey in the Houston area, many trucks in the southeast are being loaded up with water, diapers, food, and other items to help in the relief effort in Texas, further straining the supply of essential goods to the area that is about to be hit next. While shortages of essential goods have developed in many areas, there has been no shortage of articles written by economists describing how laws prohibiting price gouging lead to or exacerbate many of these shortages. For informational purposes, I’ll describe why this is in the following paragraph. What is even more interesting, is when we find examples of other economic forces at work that are largely being ignored in the other articles. In particular, this week several airlines announced that they would be doing quite the opposite of price gouging, by voluntarily capping the prices they are charging on flights to and from Florida during the evacuation effort.
Hurricane Irma Threatens Florida as People in its Path Prepare
(Photo credit: NASA/NOAA GOES Project)
Before we discuss the scenario with voluntarily capping airline flight prices, let’s first briefly examine the reason economists are so interested in price gouging laws to begin with. The reason most economists will argue against price controls of this sort that limit the maximum price that can be charged for a good, is that it prohibits the market from working to set the price that “clears the market” in a competitive equilibrium. That is to say, sometimes the price of a good needs to be very high before quantity supplied equals quantity demanded. If the price is below this point, people will want to buy more of the good (because people find it to be relatively pretty cheap) than is supplied (because many suppliers don’t find it profitable to sell a good for so few dollars). This inevitably leads to a shortage, and determining who gets the limited available quantity must be done in some other way than raising the price. One method of distributing goods in such a scenario is “queueing”, which is distributing the resource to whomever shows up first in line. If you’re worried about one person buying a lot of the good (stocking up on many cases of bottled water), instead of many people buying one case each, you could also try imposing limits on how many each person could purchase.

If you do limit the ability of prices to rise through anti-price gouging laws, most economist argue, you create two problems. The first is that people may overindulge in the artificially cheap good (stocking up on as much bottled water as possible), leaving very little or none for others (who may value it more) to purchase. The second problem is that the price gouging laws remove or decrease the incentive for entrepreneurs to transport much needed supplies to the affected areas from areas where they are more plentiful. Absent these laws, someone from Virginia may be tempted to purchase several generators and drive to Houston or Florida to sell them to people who are in great need of them, albeit at a higher price to cover their investment/expenditures.
Price Gouging Laws lead to Shortages of Many Essential Goods
(Photo credit: By Maksym Kozlenko via Wikimedia Commons)
What I want to discuss in this article, however, is not the typical price gouging scenario. Earlier this week, as predictions of Irma’s landfall somewhere on the Florida peninsula became increasingly more certain, evacuations began to take place. Then, something interesting happened. Airlines began advertising that they were doing two things. First, they were attempting to add as many extra flights as possible to get people out of Florida. Second, and somewhat surprisingly to many economists, most airlines announced that they were voluntarily capping the prices of their Florida flights at relatively low levels. While this may seem like an odd phenomenon to many, I would argue that the unique circumstances of these flights make the voluntary price capping a unique exception, and unlike other necessities like plywood, bottled water, and gasoline.

First, despite economists’ general agreement that prices should be able to rise (for the reasons discussed above), the general public tends to view large hikes in prices negatively. Thus, you may not expect many companies to raise prices by much during disasters, even if there is no law prohibiting it, due to the potential decrease in customer satisfaction. This doesn’t apply much to the entrepreneur who chooses to drive to an area to sell more generators, but it can be pretty damaging for larger companies whose reputation is on the line. Airlines have received a lot of negative P.R. already this year, and probably aren’t looking to add to it, even if they’re otherwise justified in their actions.

Second, while airlines are increasing the number of flights (and size of planes) to transport more people, there’s actually little room to temporarily increase the supply of seats flying out of Florida. One large barrier to increasing supply is the limited capacity of airports to have more planes at their gates. This means that even if the airlines charged several thousand dollars per seat, there just aren’t enough flights for it to have much of an impact on profits. When the airlines weighed the lop-sided risk of the costs of a potential P.R. disaster with a small bump in profits versus making a positive impression on the public and forgoing those profits, the choice is pretty obvious. When viewed in this light, it’s easy to see why airlines would publicly impose price restrictions on themselves.
Larger Planes and More Flights are Being Added to Help with Florida Evacuation
(Photo credit: Carla Thomas  via NASA)
The problems associated with price gouging laws are clear when applied to goods like plywood or generators, but don’t fit as well when applied to flights. It is much more plausible that someone would be incentivized to drive a truck full of supplies to Florida than to fly their small plane down, find a runway with available space, and find customers to fly out of harm’s way a few at a time. The limited ability to expand “production” of flights, coupled with the fact that a few large companies with a lot to lose control most flights, means that in this instance there’s no need for a price gouging law to limit prices. The major airlines have made a competitive and economic decision that, at least for them, price gouging just won’t fly.