Price gouging: are we shooting the messenger of inequality?

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Early in the pandemic, some people bought important supplies when the cost was low and sold them for marked up prices, i.e. they engaged in price gouging. There’s usually a pretty strong backlash against this and sometimes laws are even passed to prevent it from happening.

People with an economics background often get annoyed by this backlash. Suppose hand sanitizer was \$1 before the pandemic and a small number people bought it. After the pandemic hits, there are many more people who want to buy hand sanitizer at that \$1 price: far more people than the available number of hand sanitizers. By buying at the original price and charging more, price gougers ensure that the people that want the hand sanitizer most—as reflected in their willingness to pay more for it—actually get it. Increased demand also incentivizes companies to produce more of the relevant goods.

Why does price gouging feel wrong to us? Here’s a preliminary explanation: when we witness price gouging, we see a situation in which only two kinds of people can buy a scarce good: those who desperately need it and have to shell out a huge amount of money for it, and those with a lot of money who are simply happy to pay the increased cost. This feels like it exploits those who are desperate, and unfairly advantages those that are wealthy.

Are these intuitions about exploitation or unfairness justified?

Suppose a low-income parent with a sick child has to pay \$50 for a \$1 bottle of hand sanitizer from a price gouger. It looks a lot like the price gouger is just profiting from their desperation and creating no value. But if price gouging weren’t allowed, it’s not true that the parent would have the \$1 hand sanitizer. Instead, they’d probably have no hand sanitizer at all: it would be gone from the shelves before they arrive. Since the parent would rather have the hand sanitizer and be down \$50 than have no hand sanitizer at all, a world where price gouging is allowed is better for her than the one in which it isn’t. Price gouging makes it more likely that the hand sanitizer goes to the low-income parent and not to someone who doesn’t really need it.1

Can price gouging ever be exploitative if the exchange involves no deception and leads to an outcome that the price gouger and the parent both prefer? In ethics, this gets called “mutually beneficial exploitation” and there’s a lot of debate about whether it’s possible.

We might think that this kind of exchange is wrong because there’s a more welfare-maximizing option available to the price gouger: namely, to sell the hand sanitizer to those that need it most. This is different from what actually happens when the price gouger sells their goods because welfare isn’t tracked all that well by willingness to pay. Richer people are willing to pay more for goods that bring them less welfare, since the marginal cost of losing a dollar is lower for them.

But if “there’s a more welfare-maximizing option available” is our standard for exploitation almost all transactions are exploitative, including the store selling the hand sanitizer for \$1. There are almost certainly people who will not pay \$1 for hand sanitizer, but who would derive more welfare from the hand sanitizer than some of the people who are willing to pay \$1 for it.

Perhaps the most plausible response is that price gouging is just a particularly extreme example of this disparity between the market exchange and the one that maximizes welfare.

There are practical problems here, however. In order to determine the welfare-maximizing price, the price gouger would have to assess the needs and resources of each potential buyer and adjust their price accordingly. But identifying what resources they have and genuine need is extremely hard. A higher willingness to pay might be one of the most efficient ways for the price gouger to identify those with a higher need, given what they know.

Perhaps those with more information could try to distribute key goods in a way that maximizes welfare. For example, governments could come together and distribute hand sanitizer to those that need it most at a subsidized price. But the fact that they don’t do this is hardly something that can be blamed on the price gouger. So why do we direct our ire at them?

Ultimately, I suspect that at least some of our intuition that price gouging is wrong comes from the fact that when there are large wealth disparities, willingness to pay is a worse proxy for welfare. If someone with only \$10 is dying in the desert and comes across a water seller, the water will go to any wealthy person who is willing to pay \$11 to take a shower.

When we see these kinds of outcomes, I think we’re inclined to shoot the messenger of inequality: i.e. to blame whoever happens to be the person carrying out the final transaction. But this person is hardly to blame for the fact that such wealth inequality exists. They are also not in a good position to correct for it and are likely to be out competed if they try. (To say nothing of how this correction would affect the supply of important goods.)

If this is correct then we might want to redirect our ire at those with the ability to nudge things in a more welfare-maximizing direction. Governments can do so by redistributing some of the economic wealth we generate to the worst off, for example. But when governments outlaw price gouging, they’re probably just shooting the messenger of inequality. They haven’t improved the underlying situation—if anything, they seem to have made it worse—they’ve just shot the guy that was drawing attention to it.

Of course, it’s unlikely that the optimal distribution of wealth is a totally equal one. Wealth equality won’t be sustained if people are rewarded in accordance with the value they create and a smaller portion of a bigger pie is often better than a more equal portion of a smaller pie. So the world in which welfare is maximized in the long term might inevitably involve individual transactions along the way that are bad from a welfare-maximizing point of view. But it’s also unlikely that the optimal distribution of wealth involves the kind of disparities between the rich and the poor that results in some people taking showers next to others that are dying of thirst.

I won’t take a stance on the best balance to strike on growth and equality - I’ve already skirted some heavy economic territory here. I just want to point out that we’re often inclined to shoot the messengers of inequality even if they’re doing something that makes the world better, like making it more likely that important goods go to those that need them.

Shooting the messenger of inequality happens elsewhere too. People often think it’s exploitative to open low-wage factories or run drug trials in developing countries, for example. This is true even if people choose whether to work in those factories or to be enrolled in those drug trials, and even if their choice to do so seems reasonable given their other options.

If shooting the messenger of inequality is a real part of this phenomenon, it seems like one we should try to avoid. After all, yelling at doctors for telling us we’re sick won’t make us any healthier.

  1. There might be some kind of luck-based view about fairness at play here: i.e. it’s better for everyone to have a similar chance at getting a single hand sanitizer for \$1 than for some people to have a higher chance at getting hand sanitizer by paying more for it. The system of restricting supply per person approximates this, but there are many issues with it. For example, it requires that people be prevented from re-selling their hand sanitizer if it’s to avoid devolving into distributed price gouging. This means it can result in an outcome that everyone would prefer to change: each winner prefers to sell to a loser that prefers to buy. I’d be interested in hearing a defense of restricting supply per person, however, since it seems to be a common practice. 

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