If you’ve bought anything in the past six weeks, you’ve seen shortages. In grocery stores, you’ve see empty shelves. Online, you’ve seen long waits.
If you know econ 101, there’s an obvious explanation: price-gouging laws. When supply falls, the market’s normal reaction is to raise prices. Government’s reaction, however, is to paint the market’s normal reaction as vicious exploitation – and order prices to stay flat despite reduced supply. Shortages inevitably result.
While this story has great merit, you don’t have to look closely to realize that it’s not the full story of shortages. Why not? Because most businesses are neglecting a wide range of strategies to legally raise prices. These strategies include:
1. Stop offering discounts. This is legally very safe, but the last time I shopped at Giant and Costco.com, many discounts remained. At least at Giant, the discounts were on perishable goods, so this isn’t just a leftover from before the crisis. Firms really do continue to sell below full price even when goods are flying off the shelves. Why not just charge full price on every good in short supply?
2. Offer premium service. Stores can’t legally charge more for the same good. Yet to the best of my knowledge, there is no legal impediment to offering a new good or service at a high price. For example, stores could charge an entry fee or surcharge for shopping right after delivery trucks arrive. (If that’s too blatant, they could just arrange for trucks to arrive right before the premium period). Slight variation: Offer pricey preferred customer cards, so high-value customers don’t have to pay extra each time they shop. My local bike shop sticks to a first-come-first-served model, so there are long lines for service. They could easily offer “elite” or “platinum” or “preferred” drop-off service for double the price.
3. Impose (or raise) minimum purchase requirements. Right now, there is a long wait for Instacart delivery in my area. But you only have to order $50 to get delivery. Why not a minimum order of $100? $200? Amazon, similarly, could limit two-day shipping to high-value orders.
4. Mandatory tipping. Most delivery services strongly encourage or even require a tip. Instacart, for example, has a built-in 5% tip. They could easily raise it to 20% – then marginally cut delivery workers’ base pay so the company profits.
Why then don’t businesses apply these strategies until shortages vanish? The usual story is that they’re guarding their reputation. Economically illiterate customers see shortages as forgivable but price increases as vicious. Profit-maximizing firms therefore appease them. If customers feel like Costco is ripping them off during the crisis, Costco suffers in the long-run from loss of goodwill.
This story, too, has great merit. But again, I doubt it’s the full story. Beloved, high-profile companies like Costco might be acting prudently; when your reputation is solid-gold, you really don’t want to risk a media scandal. But even a well-known firm like Giant could easily end most discounts without drawing much ire. A newish firm like Instacart that’s exploding during this crisis could easily get away with high mandatory tips. New customers won’t even realize that anything has changed. And does anyone really expect my bike shop to suffer in the long-run if they offer premium drop-off service?
What then explains the legal and profitable price increases that aren’t happening? My preferred explanation is that businesspeople – like most people – consider price increases during an emergency to be dishonorable. And contrary to popular belief, the system generally puts fairly honorable businesspeople in charge. The adage, “That’s just not good business” means a lot to the typical person who runs a business. That’s why they try to make customers happy even when they know that repeat business is highly unlikely.
During normal times, businesspeople’s sense of honor helps the whole economic system run smoothly. In a crisis, however, businesspeople’s own misplaced sense of honor prevents them from swiftly alleviating shortages with covert price increases. Yes, price-gouging laws and customer outrage are important factors, too. But if businesspeople felt morally justified in raising prices, they would be aggressively hunting for legal and psychological loopholes. Few are.
I love business, and admire businesspeople. They’re doing a great job during this emergency. Thank you, business, for keeping us alive while we cower. But businesspeople could do even better if they believed more in themselves. Populists notwithstanding, there is nothing “dishonorable” about raising prices to eliminate shortages. If governments or customers refuse to see this great truth, there is nothing dishonorable about raising prices in less-visible ways. Businesspeople, you do not merely have a right to “gouge.” As long as shortages persist, gouging is the right thing to do. Gouge is good!
READER COMMENTS
Dylan
May 4 2020 at 10:03am
I like your explanation, but this one definitely doesn’t match with experience at the local grocery stores here in Brooklyn. There have been zero yellow cards to advertise sale prices anywhere in the store, and nothing on the receipt for anything that I’ve bought. I know that my regular store used to have very regular sales on avocados, selling them 2 for $3 or even 3 for $3, over the $1.99 each that is the regular price. That sale has completely disappeared over the last 6 weeks.
An alternative explanation for you still seeing produce sales. At least around here, produce has been the category that is least likely to experience shortages. You can’t really stock up for too long, so there’s not much incentive to buy more than you normally would, beyond perhaps accounting for eating at home more often. The incentives that stores have for offering sales prices on perishable goods during normal times, remains true in the pandemic. Perishable goods are worth more the day they arrive in the store, and are worth less on each day after, stores know that anything that doesn’t sell by a certain date is going to get thrown away or donated, so they want to make sure to minimize that as much as possible, hence discounts.
The corner grocery stores in New York work on similar economics. While most goods at those places are significantly more expensive, produce is priced similarly to the local grocery stores. I assume it is something of a loss leader to get you into the store, and then while you’re there you purchase over-priced cans of beans and beer to round out your meal.
Thomas Hutcheson
May 4 2020 at 11:39am
Gouge and donate the excess to an efficient charity.
Sergio Martinez
May 4 2020 at 2:43pm
This would be great. It would allow businesses to transfer money that they are already willing to loose by not raising prices. And at the same time it would allow prices to efficiently allocate goods among customers.
AMT
May 4 2020 at 2:47pm
I think this is a good idea! I agree that even without any legal restrictions, the corporate “image” really restricts what companies will do, and might be very effective in maintaining or even improving it, while helping markets work.
Matthias Görgens
May 4 2020 at 11:15pm
If you want to protect your reputation even more, figure out some kind of auction system so that customers feel like they set the higher price.
That’s easier for a company like instacart than for a brick and mortar store.
But alas, I think Uber’s surge shows that you need a thick corporate skin to pull even this mild version off. Uber already professes that gouge is good, but even they relent in the face of natural disaster or terrorism.
Egthere was a hostage situation in the Sydney city centre a few years ago. Understandably, most people wanted to get away from the city centre. Uber’s algorithm blindly raised prices to clear the market. Uber caught a lot of flak for that and retroactively refunded the gouging in this instance.
Gott Leib
May 5 2020 at 10:10am
Except that is only half the story. Those extra profits for the grocer will be reduced because the manufacturer/distributor will also charge more to the store. And they need that extra money to pay overtime and expand production. These aren’t excess profits, they are funds needed to increase the supply so that it meets demand.
mark
May 6 2020 at 7:33am
Which is what Bill Gates did. As marginal costs of another windows/office software is close to zero, charging even 10$ could be seen as reckless gouging. 😉
Phil H
May 4 2020 at 2:13pm
This is the point at which I seriously part company with market-oriented economists. When the market isn’t doing X, but they think it should be doing X, so they start making up psychobabble about why that is the case. If you’re going to do that, come over to the leftie side! We make up nonsense about why markets are wrong all the time! This is your happy place, join us…
If you’re going to be a pro-market economist, think you should have the intellectual consistency to accept market outcomes, even when they don’t agree with what you thought before. That’s the point, isn’t it?
AMT
May 4 2020 at 2:49pm
So LEGAL RESTRICTIONS that PREVENT “price gouging” is “psychobabble”? Nice trolling!
Matthias Görgens
May 4 2020 at 11:18pm
Huh? Have we read the same article?
Bryan Caplan spends most of the text exploring why businesses don’t route around these regulations in earnest.
AMT
May 5 2020 at 9:41am
Honestly Caplan is wrong about those theories, because they certainly don’t apply for the goods that are currently in high demand: toilet paper, hand soap, hand sanitizer, etc. These are obviously a small subset of the items one will pick up when they go to Walmart or target, so that delivery or premium service couldn’t matter. And I don’t recall seeing any sales or discounts on toilet paper or hand soap.
Sergio Martinez
May 4 2020 at 3:01pm
The thing is those market outcomes are being influenced by government intervention. In any case, having a pro market position does not imply praising every single decision that private individuals make in a market setting.
KevinDC
May 4 2020 at 3:32pm
Hey Phil –
First of all, that definitely made me laugh – no small feat for a Monday! Well played 😛
Okay, back to being a proper Monday grouch!
Good economics depends on incorporating a fair amount of psychobabble. Indeed, if you’re good at coming up with lots of psychobabble and how it interacts with economics, you can even get a Nobel Prize for your effort – Daniel Kahneman obviously comes to mind. Or Mr. Irrational Exuberance himself, Robert Shiller. Or Keynes and his notion of “animal spirits” – however, despite his lasting influence on economics Keynes himself never walked away with a Nobel Prize due to a slight case of death.
(Side note, you seem to be implying that Caplan doesn’t “accept” the current market outcome. I’m not sure why you think that – he’s not calling for it to be overridden or interfered with. I guess you could say he doesn’t approve of the current market outcome, but that’s a different thing altogether. Acceptance does not imply or entail approval, and vice versa.)
Being a market oriented economist doesn’t mean thinking that everything that happens in a free market is always optimal, and if anything appears sub-optimal that just means it’s optimal for reasons you don’t understand. I can count on one hand the number of economists I’ve met who have argued anything close to that, and, not by coincidence, they were all Murray Rothbard types. But excluding Rothbardians (always a good life decision!) I’m hard pressed to think of anyone who’s made that argument.
In my experience, market oriented economists can list of a thousand ways for markets to lead to sub-optimal outcomes at the drop of a hat. We don’t deny these problems exist. We just see them, and ask ourselves “What are the odds this situation will be reliably improved if everyone’s individual decisions about their own circumstances was instead made on their behalf by people like Nancy Pelosi and Ted Cruz?” On a scale of “Very Likely” to “Almost Never,” market oriented economists lean towards the latter.
Matthias Görgens
May 4 2020 at 11:22pm
Well, if markets don’t do what we expect them to do, it’s good to look into potential reasons why the might be so.
It’s bad to stop there, however. As good scientists we should try to figure out ways to put our speculations to the test.
Some of those tests can be just thinking things through, like Bryan Caplan does here.
Some other tests would involve looking for or generating empirical data. Those tests are more involved, of course.
Mark Z
May 5 2020 at 6:11am
“Psychobabble….”
Why do you think stores aren’t raising prices even though there are shortages then? There’s really only one explanation that supports the anti-market position: that firms aren’t very good at pricing, and they don’t know how to adjust prices in high demand even when it would be in their interest to do so. That seems highly speculative and unlikely. Companies seem well aware that market prices have gone up and are choosing to keep prices down (https://www.marketwatch.com/press-release/amazon-cracks-down-on-price-gouging-during-coronavirus-outbreak-2020-03-24-6197584?mod=mw_quote_news). In other words, Amazon knows that market prices have gone up, and could let them go up, but has chosen to prevent them from doing so out of a sense of public-spiritedness it seems.
Now, it definitely is a tragedy that capitalists often aren’t as self-interested as critics of markets imagine them to be, but I don’t think that vindicates the anti-market position. If Jeff Bezos were more like the man his critics think he is we would be better off. In any case, I don’t think we even need to resort to much ‘pschycobabble’ (an amusing way for someone from an anti-market position to describe any non-self-interested behavior) to explain the reticence to raise prices. Even where price gouging laws aren’t on the books, the threat of them may be enough to behave as if they were (“A group of 33 attorneys general from U.S. states and territories called on Amazon, eBay, Facebook, Walmart and Craigslist to prevent price gouging on coronavirus-related products.”: https://www.cnbc.com/2020/03/25/state-ags-call-on-amazon-and-others-to-prevent-coronavirus-price-gouging.html) Suffice it to say, the response “and if we don’t?” would likely not go well for these sellers. Politicians have already been bullying many of these companies for years and threatening to destroy them, and for reasons that defy common sense, this reflects much of the public’s attitude toward them. I think they know they’re on thin ice.
So I’m also a bit skeptical of Bryan’s explanation, but because I think the general precept of both traditional pro-market and anti-market thinking – that capitalists are greedy – is reasonably accurate, and that the best explanation for self-regulation by an industry is that the threat of actual regulation hanging is over them.
Phil H
May 6 2020 at 12:52am
Ugh, the internet ate my answer again. 2nd try:
Caplan: “economically illiterate customers”
Mark Z: “There’s really only one explanation that supports the anti-market position”
I don’t hold an anti-market position, fortunately. I’m pro-market, because I think customers aren’t illiterate. They know exactly what they want: stable prices. You might like that, or not like it. But that’s what they want. It’s obvious to everyone that that’s what they want. And business owners respond to that demand. Markets in action!
Henri Hein
May 4 2020 at 3:41pm
I notice many stores address the problem by limiting purchases. For instance “max 1 5lbs bag of flour per customer.” The more I think about it, the more it makes sense to me — not from an overall efficiency perspective, but from the store’s. If they raise the price, they will upset not only the customer who buys at the inflated price, but also all the customers who chose not to buy because of the inflated price. The limit presumably upsets people less, and more customers get to buy flour. So the overall customer satisfaction is probably higher.
The problem is that it doesn’t send the signal back to the producers to make more flour, but by somewhat restricting hoarding, the need to produce more is lessened.
john hare
May 4 2020 at 8:10pm
Is it possible that some of these companies could set up shadow companies that sold high without damaging the brand? Fast-N-Nasty enterprises has TP, masks, and sanitizer ready to go, without mentioning that it is wholly owned by Target.
Matthias Görgens
May 4 2020 at 11:28pm
For stores with lots of SKUs the empty shelves might be how they raise prices on the sly:
Walmart has a gazillion different products. From the customers point of view, the dozens of different toothpastes don’t vary much in utility. But they vary a lot in price and how much profit Walmart makes on them.
If you assume that usually Walmart moves more of the lower profit toothpaste, letting shelves go empty forces customers to also buy the higher margin toothpaste.
Less inventory in the shelves would also improve Walmart’s financial position.
I suspect neither of those two effects to be strong, so Bryan Caplan’s points remain very valid.
Pierre Lemieux
May 7 2020 at 12:12pm
Good point, Matthias!
Suburbanist
May 4 2020 at 11:41pm
Costco doubled prices recently by only offering “organic” versions of many products. For example, I never saw organic versions of frozen hamburger patties at Costco before the pandemic. There’s a chance that they may have simply sold out of non-organic versions, but the fact that the expensive organic products were available is an indication that they did let prices rise.
Pierre Lemieux
May 7 2020 at 12:13pm
Interesting. I suspect much of that is happening.
Ahmed Fares
May 5 2020 at 12:06am
A little pushback against gouging.
interfluidity (Steve Randy Waldman) has an article where he mentions “congestion pricing”. Here is a quote:
Let’s consider another common case about which many economists differ with views that might be characterized as “populist”. Suppose there is a limited, inelastic supply of road-lanes flowing onto the island of Manhattan. If access to roads is ungated, unpleasant evidence of shortage emerges. Thousands of people lose time in snarling, smoking, traffic jams. A frequently proposed solution to this problem is “congestion pricing”. Access to the bridges and tunnels crossing onto the island might be tolled, and the cost of the toll could be made to rise to the point where the number of vehicles willing to pay the price of entry was no more than what the lanes can fluidly accommodate. The case for price-rationing of an inelastically supplied good is very strong under two assumptions: 1) that people have diverse needs and preferences related to the individual circumstances of their lives; and 2) willingness to pay is a good measure of the relative strength of those needs and values. Under these assumptions, the virtue of congestion pricing is clear. People who most need to make the trip into Manhattan quickly, those who most value a quick journey, will pay for it. Those who don’t really need the trip or don’t mind waiting will skip the journey, or delay it until the price of the journey is cheap. When willingness to pay is a good measure of contribution to welfare, price rationing ensures that those more willing to pay travel in preference to those less willing, maximizing welfare.
Unfortunately, willingness to pay cannot be taken as a reasonable proxy for contribution to welfare if similar individuals face the choice with very different endowments. Congestion pricing is a reasonable candidate for near-optimal policy in a world where consumers are roughly equal in wealth and income. The more unequal the population of consumers, the weaker the case for price rationing. Schemes like congestion pricing become impossibly dumb in a world where a poor person might be rationed out of a life-saving trip to the hospital by a millionaire on a joy ride.
link to article: https://www.interfluidity.com/v2/5117.html
BW
May 5 2020 at 5:48am
This is highly implausible, because it assumes that the only way a poor person could afford a trip on the highway is by pricing-out a rich person. It is much more likely that a poor person will price-out someone poorer than himself, or the next-poorest person who doesn’t have as high a preference as himself.
Mark Z
May 5 2020 at 6:19am
“The more unequal the population of consumers, the weaker the case for price rationing.”
This is just wrong. It assumes 1) no supply response, which may be the case for congention pricing, but that only illustrates why that’s a terrible analogy for stuff you’d buy in a store. It’s also a nice case of using the most extreme, unlikely scenario as a synechdoce for an entire concept. Almost every poor person has a credit card, so the realistic outcome is that the poor person increases his credit card debt to pay for his hospital visit, and is more likely to get to the hospital in time and survive thanks to the congestion pricing’s reduction in the likelihood of… congestion (https://www.ncbi.nlm.nih.gov/pmc/articles/PMC32251/).
Ron Browning
May 5 2020 at 8:01am
What seems to be under appreciated in this thread is the difficulty and cost for a large retailer to respond to “panic buying”. The products that become in short supply are a small percentage of the 10’s of thousands of items that a large retailer will carry. The call to “raise prices” is almost meaningless. To confront “panic buying”, a retailer would have to raise prices on specific items, starting at a specific time, adjust those new prices at future times ( unknown in advance) and then return prices to normal at a later specific time. Intuition will not tell the retailer how much of a price increases on manicotti shells will slow the rate of sales down to match the unknown rate of future (short term) supply. The same goes for organic grass fed lean ground beef and 9” paper plates. The situation is even more complex when a retailer has multiple locations in one metropolitan area with different clientele and buying habits. If the retailer is located throughout the US, the difficulties multiply. To become even reasonably well equipped to respond to “panic buying” a retailer would have to commit lots of resources and be prepared to suffer many failures as they learn. The resources required to become good at responding to “panic buying” is probably much higher for the large retailer than honing their skills at sourcing the scarce products.
Thomas Knapp
May 5 2020 at 9:00am
“Amazon, similarly, could limit two-day shipping to high-value orders.”
Amazon should get back to providing the two-day shipping that I’ve already paid for with my Prime membership instead of moving non-Prime-members’ “essential” (translation: “I didn’t plan ahead and now that’s YOUR problem”) orders to the front of the line.
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