Alabama faces a risk of devastating hurricanes, tornadoes and floods. Do Alabamians need protection against predatory “price gouging” after natural disasters? State lawmakers apparently believe so, having passed a law against price gouging in 1996, with penalties of up to $1,000 per violation. The case of price gouging raises some interesting economic and ethical issues.

Such laws constitute temporary price ceilings, or maximum legal prices for selling a good or service. Both demand and supply factors push prices for goods and services up after disasters. Some goods become particularly valuable after a disaster, like chain saws. Disruption of electricity creates temporary demand for items like ice and generators. And damage to businesses, utilities, and the transportation system can affect the supply of goods.

Price increases after a disaster serve two economic functions. The first is to ration the available quantity of goods. If the price of hotel rooms did not rise, one displaced family might rent two rooms, leaving another displaced family without one. The second function is providing businesses an incentive to bring the needed goods to the disaster area. This might be quite a challenge with damaged roads, railroads, and airports.

In markets, supply and demand determine the price. The price needed to “clear” the market might be significantly higher after a disaster. Ice might normally sell for $2 a bag, but rise to $10 after a hurricane.

Many people might consider $10 to be excessive relative to the normal $2 price. The view that $10 is excessive is based on confusion about the nature of economic knowledge. People might think that since the laws of nature are unchanged after a disaster (it takes as much energy and water to make ice as before), the cost of ice must be the same. Yet cost is an economic and not a physical science concept. Economist Friedrich Hayek pointed out that economic truth depends on circumstances, in contrast with the physical sciences’ general truths. Ice normally does not sell for $10 a bag, but disaster victims do not want ice under normal conditions. Briefly in a disaster area ice is worth $10 a bag.

It would be great if the needed quantities of goods and services were available for the same prices as before the disaster. But simply preventing the price from rising does nothing to get the goods to where they are needed now.

Harvard philosopher Michael Sandel, a thoughtful critic of markets, argues that raising prices more than necessary after a disaster is a profoundly anti-social action. He writes that “A society in which people exploit their neighbors for financial gain in times of crisis is not a good society.” Price gouging laws signal society’s disapproval.

I think Professor Sandel has a point. Charging disaster victims $10 a bag for ice that you would be willing to supply for $5 is not a virtuous act. Yet the question is how best to ensure that disaster victims get the ice they need for no more than necessary. Price gouging laws are a poor means to accomplish this. Alabama’s price gouging law prohibits an increase in price of more than 25% unless “attributable to reasonable costs incurred in connection” with provision in an emergency. The fuzziness of costs, which I have discussed recently, renders such a provision meaningless.

Competition is the best way to ensure that prices reflect costs. If a business is gouging buyers, another can undercut the price. In practice, laws against price gouging limit competition. Government economists and lawyers cannot precisely distinguish reasonable versus unreasonable costs, so enforcement becomes a crap shoot. If being prepared and able to sell needed goods after a tornado, albeit at higher prices, creates a risk of prosecution, businesses are more likely to just remain closed.

We may disapprove of businesses’ “excessive” greed, even if we have difficulty defining exactly when greed becomes excessive. Nonetheless, market competition offers the best way to limit the excesses of greed while harnessing its power to benefit our economy.

 

Daniel Sutter is the Charles G. Koch Professor of Economics with the Manuel H. Johnson Center for Political Economy at Troy University and host of Econversations on TrojanVision. Respond to him at dsutter@troy.edu and like the Johnson Center on Facebook.