James Kwak and I will agree on one thing with respect to his recent post: people who have taken econ 101 will tend to believe that price gouging in a disaster is a good thing. Where Kwak and I disagree is whether price gouging actually is a good thing. Here is how he lays out his case:

…the Econ 101 argument is that raising the price allocates the shovels to people who will derive more utility from them (because they will pay more), thereby increasing social welfare.

But this rests on a huge assumption: that willingness to pay is the same as utility. Unfortunately, however, this assumption fails in the real world; poor people simply can’t pay as much for snow shovels as rich people, and as a result a price increase will allocate shovels to rich people, not to those who need them the most.

James concedes that he doesn’t think “there is a perfect way to allocate the shovels, just that using price isn’t perfect, and does have inequality effects”. Since we can’t directly measure utility, and willingness to pay is just our proxy for it, no it’s not perfect. But it is the best way best possible way available to allocate scarce resources in this scenario. Notice James doesn’t just not offer a “perfect” alternative, he offers no other alternative that he believes will be better. Willingness to pay may not be a perfect measure of utility and to maximize social welfare, but it sure as shit is a better than first-come-first-serve.

If James is trying to play our innate sense of fairness against efficiency criteria he should have chosen a more compelling case. Am I really to believe that the $20 price of snow shovels is really pricing poor people out of the market and that they literally can’t pay for them? Because they could afford them at $15, right? Otherwise, the “price gouging” isn’t really an issue since poor people aren’t being priced out of the market.

I mean if he was talking about how we allocate the seats on the last spaceship off of earth before an asteroid destroys it, then yeah, we get into some serious moral issues where simply allowing markets to determine who gets the seats would give us an outcome that would really seem wrong.

But $20 snow shovels when the price is normally $15? I think that’s probably both efficient and fair. And the fact of the matter is that in the real world this is where most supposed “price gouging” happens, for smaller priced items like water and gasoline. The slight inequality that results from these dozens of dollars is far outweighed by preventing people who value these goods little from hoarding and overusing them simply because they got there first.

One other point is that Kwak may be right that “In this case, supply is fixed in the short term, so raising the price won’t increase supply”, but if you allow prices to rise, then it gives stores more incentive to overstock their shelves the next time they anticipate a snow storm. If you prevent them from raising prices, then they won’t have incentive to overstock.

Price gouging is definitely econ 101 stuff, but it’s one case where econ 101 gets it right. Contrary to James point at the end that “public policy largely follows the dictates of Econ 101″, price gouging is one area Econ 101 conclusions don’t in fact determine public policy. According to this FTC report from 2006, 29 states and D.C. have laws preventing “price gouging” in gas and other commodities during supply disruptions. Clearly Econ 101 still has a long way to go if it’s going to win this one.

UPDATE: Eric Crampton writes in the comments: “Here in earthquakeland, there wasn’t any price gouging; stores predictably ran out of water, bread, batteries. Sigh”