ORLANDO, Fla. (AP) -- The oak tree in Ilyse Kusnetz's back yard caused one headache when it crashed into her house during Hurricane Charley. Now the tree is sprouting a second worry: price gouging.
Kusnetz, 38, said Wednesday that she didn't have enough time to get several estimates from companies willing to cut it down and haul it away, so she's paying an Ohio-based crew $2,400.
"That might be reasonable and that might not, but there's no way of knowing," she said. The price could drop after a wait, Kusnetz acknowledges, yet a delay could bring more damage to her house.
In Charley's aftermath, price gouging is a growing concern in Florida. . . .
The state has received 1,854 gouging complaints from consumers in a week, the Attorney General's office said Wednesday. Those include purchases of hotel rooms, gas, lumber, hardware, generators, ice and water.
. . . State law says anyone who price gouges in a disaster area can be fined $1,000 for each offense up to $25,000.
$2400! In a natural disaster, its not just trees that go through the roof; so do the prices of necessities like water, plywood, ice, electric generators and, yes, tree removal services. Where's the good ol' magic of the market when you really need it?
Don't worry, it's still there. In fact, hurricane season every year is an excellent reminder that we can count on the interaction of self-interest, the profit motive, and the invisible hand of competition to work in the interests of society as a whole. Following the recent Florida hurricanes, an army of craftsmen, workers, and supplies needed to repair the damage and restore a semblance of normalcy appeared virtually overnight. In fact, some of the troops showed up before the wind started to blow. And believe it or not, it was the good ol' magic of the market - not committees, bureaucrats, and government officials - that brought the goods and services so desperately needed.
How Does It Work?
Markets' "magic" lies in their ability to process uncountable bits of information and transmit the results in the form of prices. That's an amazing feat that no computer in the world can perform. The prices then allocate resources to their most valuable uses. Importantly for our discussion, markets consider both the present and the future when allocating resources and generating information. As the season develops, markets shift resources for storm protection and clean-up away from inland regions that value them less and to hurricane-prone regions that value them more.
Consider two key problems created by hurricanes: physical destruction of buildings and property, and the loss of electricity due to fallen power lines. Wouldn't it have been helpful if, once the hurricane predictions were posted, areas of the country that didn't expect hurricanes had shipped plywood, building materials, and electrical generators to Florida? Of course, it would have been helpful - and, thanks to the magic of the market, it was!
Hurricane Frances Means Shortage Of Some Supplies
As people in Florida brace for their second major hurricane in a month, the effects are being felt 1500 miles north in Green Bay. . . .
[As the local television news in Green Bay, WI, reported:] If you're looking to buy a generator this weekend, you might have to hunt longer than usual. Home Depot on Eaton Road has already shipped a lot of their stock to Florida, and are [sic] trying to replace them.
. . . While the store is shipping generators south, they've noticed area residents doing the same. . . . "We've had a couple of instances where people are buying them to send them down or take them there personally."
As worried residents flood stores trying to prepare for Hurricane Frances, one Home Depot in Florida more than doubled its daily sales this week, pushing 50-thousand dollars worth of plywood out its doors in a single day.
http://wfrv.com/topstories/local_story_248234030.html Sep 4, 2004 9:40 pm US/Central
The magic wasn't limited to plywood and generators. Prior to storms, and immediately following, the expectation of increased demand for goods and services drew people and products from across the country. Suppliers know that increased demand means higher prices and greater quantities purchased, and that means increased profits. In effect, the rising prices acted like magnets, drawing in the very goods and services needed by Florida's hurricane- battered residents. Bottled water flowed in. Ice was shipped by the trailer full. Carpenters, painters, construction workers, arborists, cleanup companies, and hundreds of other trades-people headed south.
Ok, but let's get back to having to pay thousands of dollars to get a tree off your house. Isn't that like kicking someone when they're down? It might seem that way until we recognize that shifting resources to places and people that value them more is not costless. Reallocating inventory to different stores means transportation and stocking costs, and it may leave some stores without products to sell. People who come to provide services leave customers and opportunities behind. Uncertainty is a cost, too - suppose the hurricane forecasters are wrong? Each of these factors combines with the increased demand from consumers to increase prices. The important point is this: The higher prices are a good thing in the sense that without them, the fantastic flows of goods and services would not occur.
When Is It Price Gouging?
Of course, not everyone sees it that way. The $5 bag of ice priced $1 a week ago, the double hotel room rates, the entry fees at restaurants are commonly called price gouging. They make people mad, and in many states, they're illegal.
Is a $10 Bag of Ice Illegal ?
By Brendan Koerner, Slate, MSN
Hurricane Charley has reportedly brought out the worst in some merchants, as the Florida attorney general's office has been inundated with complaints about price gouging. Among the travesties cited are a $10 bag of ice in Orlando, $3 gallons of gas, and $2,000 power generators. . . .
In Florida, as in at least 20 other states with similar laws on the books, pricing curbs kick in during declared emergencies-say, when thousands of residents have been walloped by a natural disaster. The standards vary from state to state, but the rule of thumb is that gouging occurs when a good or service-especially those deemed essential, such as fuel or food-costs at least 10 percent to 25 percent more than the norm prior to the emergency.
Not every state's price-gouging law details how much of an increase will make a markup illegal. The Florida law, which was passed in 1992 in response to massive gouging in the wake of Hurricane Andrew forbids vendors from charging an "unconscionable price" for their wares during an emergency.
The motivation for Florida's law lies in the idea that it's possible to charge "too much" for a good or service. Economists find this idea suspect, arguing that market prices can't be "too high" because when exchange is voluntary, parties only enter into a sale when they think they'll be better off. Analysts also point out that while price-gouging laws may be well-intentioned, their effect is exactly the opposite of what's desired. Preventing prices from rising reduces the expected profits of shifting resources, which slows the flow of goods and services into disaster areas.
Gouging Gets A Bad Rap, Economists Argue
Scott Barancik, St. Petersburg Times Staff Writer
August 30, 2004
. . . Hurricane Charley is providing the first serious test of . . . [Florida's] antigouging law. State Attorney General Charlie Crist, whose antigouging hotline has fielded more than 3,300 complaints and spawned five lawsuits since the 60-day state of emergency went into effect Aug. 10, said he's already "starting to see a deterrent effect." But economists predict the law may produce an unintended result, as well: artificial shortages of labor and construction supplies.
. . . University of Florida economist Dave Denslow explained the theory. After a hurricane or other devastating event, demand for necessities temporarily outstrips supply, giving suppliers the ability to raise prices. If the free market is allowed to work, the theory goes, out-of-town suppliers and contractors lured by the promise of huge profits will swarm the affected communities. Prices will begin falling naturally.
But if state officials interfere by enforcing an antigouging law, Denslow
said, out-of-town suppliers may stay put, shortages would persist, and
economic recovery would be delayed.
. . . "Sellers who do not gouge prices do not do themselves or
consumers any favors," a St. Petersburg Times reader wrote in a
September 1992 letter to the editor. "They encourage hoarding and
lessen their (own) ability to keep supplies coming."
Butterworth is "unwittingly exacerbating the desperate situation in south Florida," Competitive Enterprise Institute analyst Matthew Hoffman wrote in a Miami Herald opinion piece the same month.
Butterworth's viewpoint hasn't changed since Andrew. In his mind, the debate over gouging pits ivory-tower elites like Hoffman against corrugated-shack realists like himself, people who have witnessed abject human suffering firsthand and believe businesses have a responsibility to act ethically in disaster situations. . . .
"There are certain moral imperatives that are more important than market efficiency," acknowledged . . . [former California state chief economist Philip Romero]. . . who has studied post-disaster economic recoveries. "We are all entitled to our opinions and values. I guess the question becomes, how much of an economic cost are you willing to bear for your imperative? I'm not a theologian; I'm an economist. So on one level I can't refute . . . [Butterworth's] . . . argument, except to say that everything has a cost."
Some free-market advocates turn the morality argument on its head.
Why should one hurricane victim be prevented from paying more money for better or faster service, just because another hurricane victim can't or won't, asks Edward Hudgins, Washington director of the Ayn Rand-influenced Objectivist Center.
Similarly, why should a vendor have to price his product within the
reach of the poor or the homeless after a disaster, when there's no
such requirement during normal times? . . .
It's not that free-market boosters oppose all government regulation.
Joe Best (sic), president of the libertarian Heartland Institute in
Chicago, said consumers need to be protected from fraud and deceit in
order for the marketplace to operate optimally. But there is nothing
wrong with charging as much money as the market will bear.
http://www.sptimes.com/2004/08/30/Business/Gouging_gets_a_bad_ra.shtml
The Law of Supply Works
Ms. Kusnetz had to pay $2400 - $2400! - to have a tree removed, but the bottom line is, it was removed, preventing further damage to her home. The question we have to ask ourselves is not whether we like that she had to pay that much or whether it was fair. (Hurricanes are "fair"?) The question that economic reasoning leads us to is: Is Ms. Kusnetz better off having the opportunity to have the tree removed for $2400 or is she better off without the opportunity at all? And, if you're tempted to think this question is merely hypothetical, read on.
Paul Davis Restoration, a Clearwater company that specializes in post-disaster renovation, chose not to bid on hurricane projects.
Expenses would be double or triple normal levels, sales associate Jeff Norris said, and would require the company to charge much higher prices than usual. Customers might mistake it for gouging.
"We're easy targets out there," Norris said. "You get these little old ladies out on Channel 8 (news) saying, "That contractor, he gouged me.' What she neglects to say is that her house was under two feet of water and we saved her butt."
http://www.sptimes.com/2004/08/30/Business/Gouging_gets_a_bad_ra.shtml
Ultimately we must remember that supply curves slope upward. We induce people and companies to provide more of a product by paying higher prices. Higher prices may not fit your definition of magic, but you have to acknowledge that they are the only reliable incentive we know for increasing supply.
Document Interpretation Questions
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Suppose that you are an arborist from the state of Ohio. Hearing about the widespread damage that a hurricane caused in Florida, you pack up your truck and drive all night in order to find work cleaning up fallen and damaged trees. Suppose that arborists in Ohio earn $300/day (after costs). Further suppose that living in Florida will cost you $100/night for a hotel and $20/day for food, and that the cost of getting to Florida and then driving home after five days work is $500.
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What is the minimum amount that you must earn (per day) in order to make driving to Florida worthwhile?
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What if you factor in that you hate driving long distances, your family will miss you, and you may lose local customers while you're gone. What do you need to earn per day now?
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Suppose that you can choose to go to any of the cities in south Florida.
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If "Beach City" has passed an anti-scalping law and "Swamp City" has not, in which city will you offer your services?
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If all other conditions in the 2 cities are relatively equal, which city is likely to recover from the hurricane first?
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Suppose that the pre-hurricane price of a bag of ice is $1, and that the market clearing price for ice after the hurricane would be $10 if it weren't illegal to sell ice for more than $1.
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Will ice be sold to the users who value it most?
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Will people voluntarily choose to conserve ice?
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Is there an incentive for the store owner to increase inventories of ice prior to hurricanes?
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Will there be more ice or less ice available because of this law?
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When the price of ice is held below the market equilibrium price by law, how is ice rationed?
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Discussion Questions
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Economist Philip Romero, quoted in the "Gouging Gets A Bad Rap" article, contends that not only do gouging laws discourage supply, they encourage demand. Give an example that illustrates how anti-gouging laws encourage people to buy more, and explain whether that is a desirable or undesirable development in the aftermath of a natural disaster.
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It's easy to see why producers and suppliers would welcome higher prices after a hurricane, but what about consumers? Suppose that you live in a hurricane-damaged community. Describe a scenario in which you would be glad that the price of ice, or gasoline, or plywood, or generators, had increased.
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Two of the businesses targeted with anti-gouging suits in Florida are a restaurant that charged a $5 entry fee and a hotel that increased the room rate from $55/night to $100/night.
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Neither of those businesses supplied more; the number of tables and chairs in the restaurant and the number of rooms in the hotel remained the same. Nonetheless, their opportunity costs increased. Explain.
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How does the $5 entry fee and the doubled room rate help relieve the shortage of restaurant space and hotel rooms?
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Uncomfortable Question: Florida law prohibits the charging of "unconscionable" prices. Suppose you are called in the jury pool for gouging cases. How will you decide what's "unconscionable"? Make a list of personal rules or guidelines you would use to determine whether a seller's price is unconscionable. (Reminder: The seller's personality isn't on trial; the price is. Your personal rules or guidelines should not deal with whether or not the seller is nice. They should focus on the price.)
Teacher Guide
The student reading is followed by 2 exercises that can be used independently or in sequence.
- "Document Interpretation Questions" is intended for students beginning their study of how price controls affect supply, demand, and price. Students can find the answers to the questions in the article.
- "Discussion Questions" is a more difficult, small group activity. Students must supplement the information in the reading with knowledge of other economic concepts (opportunity cost, for example), and background in applying economic reasoning.
Answering the Document Interpretation Questions may give students the confidence to tackle the Discussion Questions. Proceeding directly to the challenge of the discussion questions may generate a more enthusiastic response for honors or AP students.
Suggested Answers - Document Interpretation Questions
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- more than $520/day ($300 + $100 + $20 + $500/5)
- a great deal more than $520/day
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- Swamp City
- Swamp City
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- Not necessarily. It may depend on their ability to get in line first or wait in line longest.
- b. Some will out of conviction or sense of duty, but there will be little price incentive to do so. In general, there will be little conservation.
- No - to do so would be costly and if the price is not allowed to rise, store owners will lose money by increasing inventories.
- Less
- Generally, by first-come, first-served, but also by favoritism.
Suggested Answers - Document Interpretation Questions
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Economist Philip Romero, quoted in the "Gouging Gets A Bad Rap" article, contends that not only do gouging laws discourage supply, they encourage demand. Give an example that illustrates how anti-gouging laws encourage people to buy more, and explain whether that is a desirable or undesirable development in the aftermath of a natural disaster.
It is important to separate the effects of the hurricane - which changes demand - and the effect of the antigouging legislation, which impacts quantity demanded.
Recognize, first, that the damage caused by the hurricane increased demand. For example, with the electricity out, the food in your freezer and refrigerator will spoil, so the demand for ice increases. (Students may explain this simply as "Everyone wants more ice." In the graph below, that change is signified by the shift from D1 to D2.)
When people get to the store and confront the price of ice, they decide how much to actually buy. In an unfettered market, people arriving at the store would find that the price of ice had jumped significantly and the higher price would encourage them to modify their estimate of how much ice they really needed to keep their food from spoiling. (In the graph below, the original intent to purchase Q1 is modified by the higher price to an actual purchase, or quantity demanded, of Q2.)
Philip Romero is referring to the effect of people arriving at the store to find that the price of ice has not changed. In that instance, they have no incentive to modify their intended purchase - hence his comment that demand is "encouraged. In the graph below, because the price hasn't changed, people are "encouraged" to purchase Q1. They've received no signal - from the price - that there's any reason to conserve. Unfortunately, because the price hasn't changed suppliers aren't willing to provide anymore than they were before the storm - Q3, resulting in a significant shortage. This is clearly an undesirable situation!
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It's easy to see why producers and suppliers would welcome higher prices after a hurricane, but what about consumers? Suppose that you live in a hurricane-damaged community. Describe a scenario in which you would be glad that the price of ice, or gasoline, or plywood, or generators, had increased.
What do you want the price of ice to be after the storm? It depends. If you are the first person to reach the store or you have nothing in your refrigerator anyway, you'd like the price to be $1. If you can't get to the store first or if you value the ice very highly (you have a new baby and need to keep milk cold), you'd probably want the price to be higher so that there wouldn't be a shortage. A low price discourages suppliers and encourages demanders. A higher price encourages suppliers to provide more ice and encourages other people to conserve, meaning a greater chance that ice will be available for you.
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Two of the businesses targeted with anti-gouging suits in Florida are a restaurant that charged a $5 entry fee and a hotel that increased the room rate from $55/night to $100/night.
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Neither of those businesses supplied more; the number of tables and chairs in the restaurant and the number of rooms in the hotel remained the same. Nonetheless, their opportunity costs increased. Explain.
The opportunity cost of renting a room or providing a table to Joe is the value of the next best alternative - that is, the amount that another person would pay to rent the room or have a seat at the restaurant. If other people are willing to pay more, as they are after the hurricane, the opportunity cost of your decision to seat Joe or rent him a room has gone up.
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How does the $5 entry fee and the doubled room rate help relieve the shortage of restaurant space and hotel rooms?
The entry fee and the higher room rate encourage people to look for substitutes. At $100/night, some people will think twice about renting 2 rooms, and have the kids sleep on the floor in sleeping bags, or will decide that staying in their in-laws' spare room isn't such a bad idea after all. Some people who would have sat in the restaurant all day with a cup of coffee will buy coffee at a drive-thru rather than paying the $5 entry fee.
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Uncomfortable Question: Florida law prohibits the charging of "unconscionable" prices. Suppose you are called in the jury pool for gouging cases. How will you decide what's "unconscionable"? Make a list of personal rules or guidelines you would use to determine whether a seller's price is unconscionable. (Reminder: The seller's personality isn't on trial; the price is. Your personal rules or guidelines should not deal with whether or not the seller is nice. They should focus on the price.)
Answers will vary; expect that some students to say no price is too high, but that many will go through tortured reasoning to come up with a formula. State laws that specify an allowable increase range from about 10 - 25%. Picking a cutoff is impossible. For example, if 25% is acceptable, why not 25.5% and if 25.5% why not 26%. If not 26% why not 27%, why not 2000% since we can get there .5% at a time. Also, suppose the store owner could use the ice himself and values it at $20. How much should someone have to pay him in order to give it up?
Sources
Associated Press. "Consumers Complain of Price Gouging in Hurricane
Charley's Wake." Billings Gazette. August 19, 2004.
http://www.billingsgazette.com/index.php?tl=1&display=rednews/2004/08/19/build/nation/43-charley-prices.inc
(9-29-04)
Barancik, Scott. "Gouging Gets A Bad Rap, Economists Argue."
St. Petersburg Times. August 30, 2004.
http://www.sptimes.com/2004/08/30/Business/Gouging_gets_a_bad_ra.shtml
(9-29-04)
"Hurricane Frances Means Shortage of Some Supplies." WFRV.com
- CBS 5 News, Green Bay, Wisconsin.
http://wfrv.com/topstories.local_story_248234030.html
(9-29-04)
Koerner, Brendan. "Is a $10 Bag of Ice Illegal? When It's Price
Gouging and When It's Just Really Expensive." MSN Slate, August 18,
2004.
http://slate.msn.com/id/2105339/
(9-29-04)