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.

Total Eclipse of Supply - Why are Solar Eclipse Glasses Impossible to Find?

America is gearing up for its first total solar eclipse in well over a quarter century, and there’s something strange going on near the path of totality. No, I’m not talking about the possibility of Lizard Man sightings during the eclipse, but rather the fact that there appears to be a shortage of the cheap disposable solar eclipse viewing glasses that are essential to wear if you want to look at the sun without permanently damaging your eyes. This article, from Denver, describes the difficulty that people from Oregon to South Carolina are experiencing in finding the glasses in the waning hours before Monday’s eclipse. I’ve discussed shortages before on this blog, so why is this one so strange/unexpected?

A total eclipse over the United States is a once-in-a-generation phenomenon
(Photo credit: NASA  via Wikimedia Commons)

The shortage of solar eclipse glasses is interesting because it should qualify as a relatively competitive market (many buyers and sellers; free entry/exit; etc…), and the product is relatively inexpensive and quick to manufacture and distribute. In addition, science allows us to predict future eclipses far into the foreseeable future, so it’s not like this event suddenly snuck up on everyone. Thus, despite there being no specific laws placing a price ceiling on solar eclipse viewing glasses (some states’ general price gouging laws could potentially apply, but I’m not aware of any being applied at this time), a shortage of eclipse viewing glasses has emerged. So, you may be asking yourself, what kind of factors would contribute to such an economic anomaly?

When a competitive market experiences a shortage, it usually adjusts for the disequilibrium created (quantity demanded > quantity supplied) by increasing prices until the market reaches equilibrium. This occurs because, as prices rise, more suppliers are willing to produce more eclipse glasses, and at the same time some consumers stop demanding pairs of glasses because the price gets too high for them. We expect this to take a bit of time to occur, but even if there were no additional time to produce more pairs of glasses the price of glasses should increase a lot until enough consumers drop out and there is no longer a shortage.

The path of "totality" stretches from coast to coast!

(Photo credit: Wikimedia Commons)

There are two interesting things that appear to be occurring with eclipse glasses. First, it appears that both producers and consumers may have underestimated the Demand for these glasses. This is likely do in large part to the rarity of total solar eclipses in the United States. It’s hard to predict the level of Demand without much historical data, especially due to the lack of eclipses that could be hyped up by so many internet and 24/7 news stories. When stores that don’t typically sell eclipse glasses (hardware stores, gas stations, etc…) were deciding how many pairs of glasses to order to stock their shelves, they seem to have preferred erring on the side of underestimating Demand. This makes sense; while eclipse glasses are relatively cheap to produce and store, their value drops to almost nothing after the eclipse on 08/21/2017. The next total solar eclipse in the US is not until 2024, and only overlaps with this year’s path around southern Illinois/southeast Missouri. That leaves a lot of stores across the nation that would have to store any excess glasses with very few potential buyers after Monday.

The second complication, that may be the most interesting to an economist, is that many groups began advertising several weeks before the event that they would be handing out eclipse glasses for free. Some were schools, museums, and other government institutions who may have been seeking to promote the “public good” by helping protect people’s eyes while encouraging people to pay attention to this scientific phenomenon. Others were retail establishments, including many optometrists, who used the free glasses as a form of advertising and a way to get potential customers in their doors. No matter their reasons, these free glasses seemed to have two effects. First, many suppliers knew they’d be trying to sell glasses against others who were giving them away for free, and so they logically ordered fewer than they otherwise would have. Second, many consumers (like me) heard that there were free glasses available, and chose to pass by those that were for sale in the store a few weeks before the eclipse.

Were you able to snag a pair of these stylish and necessary frames?

(Photo credit: nps.gov)

By the time everyone realized that Demand was much higher than expected, it appears to have been too late. No longer being able to find free glasses around town, consumers turned to the stores selling the glasses. Prices appear to have been a bit “sticky”, with the high Demand not being fully revealed to the stores selling the glasses until they had almost sold out. If they had raised their prices immediately only to find that Demand was low, consumers would have only bought from their competitors, and they would have been left with a large excess of glasses with no buyers.

One additional complication in this ordeal was the emergence of “fake” solar glasses sold on Amazon and elsewhere. Many people purchased glasses for themselves and their families only to be told that they may not be fully protected from the solar rays after all, and that they would need to find the “approved” version of the glasses. Whole counties even ordered and distributed these unapproved glasses! As any given person only needs one pair of approved glasses to view the eclipse, many people who would have otherwise been satisfied and not purchased more glasses at any (positive) price were now thrust back into the market to try to buy a pair of glasses in time.

We typically expect a market to self-equilibrate over time, unless some sort of barrier (such as a price control) keeps it from doing so. With the Great Eclipse of 2017, we can see that a confluence of unique circumstances has created a shortage of eclipse glasses that it appears will persist through the end of the phenomenon. With a little economic insight, we can “shed some light” on this mystery, just in time for Monday’s darkness.

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.