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.

Credit for Trying - Is Banning Transactions Fees a Win for the Consumer?

Take a second and think back to the last time you bought something that was on sale. How great did it feel? It’s easy to recognize and appreciate deals when you get a better price for something you were going to buy anyway. But how do you feel when the tables are turned, and you’re charged extra to buy something?

For example, when you go to the gas station to fill up your SUV, do you pay with cash or credit? At most stations, the price that you pay per gallon when using cash is different than the price per gallon for using credit. Either way, you’re getting the exact same gasoline, so how do you perceive this difference in price? If you see it as a mark-up or extra fee for using credit, you’re probably not a huge fan of the price differential. On the other hand, if you see it as a discount for using cash, you may view it favorably, and would be unlikely to want to see the discount removed.

When you purchase something, you often weigh 
the cost and benefits of using cash vs. credit

(Photo credit: 401kcalculator.org)

It is with this in mind that this article from The Telegraph, across the pond in the UK, caught my eye. The article was written by The Telegraph’s Consumer Affairs Editor, who chalks up a new law banning charging many credit card fees as a clear victory for consumers. If the title of the article, “[e]nd to rip-off credit card fees…” doesn’t make this position clear, the description of these “rip off” fees as being “used by shops, restaurants and travel firms to make extra profit at the direct expense of customers choosing to pay by card” should remove all doubt. But is the removal of these fees truly a clear “win” for consumers, at the expense of the greedy shops, restaurants, and travel firms?

Let’s begin by considering a portion of the quote above. These fees are charged to customers who are “choosing to pay by card.” This implies that the customers have other options (usually cash), but find paying by card to be preferable for some reason. Presumably, either they find using credit more convenient, or they may receive some cash back or points for using their credit cards. No matter the reason, some citizens chose to pay in credit despite the fee, and others chose to avoid the fee by paying in cash. Essentially, you’re free to sort into the group (cash or credit) that you feel is the best deal for you, after taking the fees into account.

Now what happens if you ban the ability to charge credit card transaction fees? If you’re a consumer, perhaps you’re hoping that the cash price will stay the same, and the credit price will be lowered to match it. Those who previously paid in credit would now be better off, since they still get the perks (convenience, points, etc…) of using credit, but for a lower price. If this scenario were to play out, even those previously using cash would be as well off, if not better off. Some of them may even choose to switch over and begin using credit cards for their purchases! Consumers would clearly be better off, and the costs would fall on either credit card companies or those greedy shops, restaurants and travel firms. The problem is, this scenario has some assumptions that aren’t likely to play out in the real world.

How do you view the price difference in
paying for gas with cash vs. credit?

(Photo credit: 127driver via Wikimedia Commons)

The issue with the scenario above is that it assumes the cash price will stay constant. It’s like assuming that if gasoline is currently $2.00/gallon when using cash, and $2.10/gal when using credit, that all gas would be $2.00/gal after the fees were banned. But it’s costly for gas stations and other stores to offer the payment option for credit cards. They even have to pay fees to the credit card companies for facilitating these transactions. If gas stations can’t pass along these fees to consumers, they have to find some other way to not lose money on the transaction. In this example, gas stations will do one of two things. First, they may increase the price of gas for everyone, let’s say to $2.05/gallon. While those consumers using credit cards are now better off, those who still use cash are clearly worse off, as they are helping subsidize the purchases of their credit using neighbors. The other possible result of the ban on fees is that vendors may choose to cease offering credit cards as a payment option all together. In this case, those who previously used credit cards are clearly worse off, as they used to have to choice to use either cash or credit and chose credit, but now must choose their second best option.

The lessons in the example above could easily be extrapolated to apply to all sorts of shops and firms. It’s easy to see that a law which essentially limits the choices of the consumer is not necessarily a clear “win” for all consumers, or even the average consumer. Viewing the issue as a discount for using cash rather than a penalty for using credit allows us to see more clearly the true costs and benefits of such a regulation. Perhaps The Telegraph is giving lawmakers more credit than they deserve.

No 'Free Parking' in Real-Life Monopoly?

It’s a tradition as old as consumerism itself. You’ve mastered the art of procrastination, and it’s now Christmas Eve and you have yet to finish buying presents for your loved ones. Unless you’re lucky enough to live in a city where Amazon offers same day shipping, you’re going to have to venture out into the cold to shop at an actual store. But everyone knows you don’t venture out to just any store for Christmas presents, you head to your local shopping mall! The problem is, everyone else has the same plan, and you find yourself circling the parking lot for hours, looking for a place to leave your car before the stores close or sell out of Tickle-Me-Elmos.

Wouldn’t it be great if there were a way to deter others from using up all of these parking spots that you find so valuable? Well one mall in Colorado is attempting to do just that. According to this article from an NBC News affiliate in Colorado, the Cherry Creek Mall in Denver has decided to begin charging for parking in its surrounding lots and garages. In terms of economics, we can speculate on why this change was made (and whether it’s a good or bad idea) from a couple of different perspectives.

It’s possible that the mall is charging for parking spots specifically to improve the use experience on days like the one described above, where the fixed quantity of parking spots available is exceeded by the number of shoppers looking for them. The mall may consider that happier shoppers who are willing to pay a bit to park may also be the types of shoppers who will spend more in the stores inside.

The mall is more likely to be making its decision using a profit-maximization framework. Clearly, assuming some people continue to choose to park at the mall for more than an hour (the first 60 minutes will be free), the mall will be bringing in more revenue from parking than when parking was free. The first question, however, is how many customers will be turned away by the new up-front fixed cost of shopping at the mall, and how this will impact the sales of the mall’s tenants? The mall is hoping to gain more from charging people to park than it will lose through a decrease in the prices it is able to obtain from charging stores to lease spots within the mall. These factors are influenced both by the elasticity of demand for parking, as well as the elasticity of demand for tenant space in the mall itself.

The elasticity of demand for parking is a measure of how many fewer people will park at the mall, if the price of parking increases. It is largely dependent on how many substitutes people can find for parking at the mall. These could take a variety of forms. If people are mainly parking at the mall now to shop at the mall’s stores, then substitutes could include parking elsewhere and walking or riding over to the mall to shop, parking and shopping at other malls or shopping centers, or even staying home and shopping online. There may also be people, however, who use the mall’s parking facilities as a free way to store their car close to downtown Denver, and then travel into town via public transportation or carpooling. These people may choose to instead park closer to downtown, or to find a lot farther out which is less expensive. It will depend on the cost of other parking and transportation options available to them.

It is clear from the mall’s ability to increase prices that it is not in a perfectly competitive market for parking in the area. This is because, while the potential substitutes above exist, many consumers will find spots close to mall (especially garage spots) to be more valuable/higher quality than spots in nearby areas. With this limited monopoly power, standard analysis will show that raising prices and restricting quantity can maximize profits for the monopoly, although it would likely decrease overall welfare, as those previously parking at the mall for free who now don’t park there at all lose Consumer Surplus in the amount of what they would have been willing to pay to park in the mall lot (more than $0 but less than the new price).

So did the mall make the best choice for how to handle its parking situation? This largely depends on what its other options were. Another solution that may have been considered, and may limit the backlash from the public to some extent, would be to have stores validate parking if a purchase is made. This would allow the mall to more directly target the two different groups of people who are looking for parking spots; shoppers and commuters. If the mall is able to raise the price of parking for commuters, but keep the parking free (through reimbursement) to shoppers, it can improve upon any issues with congestion and a shortage or spots without giving up too much revenue from its store tenants. So if you live in the Denver area, keep in mind that while the new parking fees may be irritating now, they could save you a huge headache when you’re already back at home with family and friends on Christmas Eve, instead of sitting in a snowy parking lot for looking for a spot.