The Answer Is Transaction Costs

Price Gouging or Price Information?

August 20, 2024 • Michael Munger

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Can high prices during emergencies actually save lives?  Using North Carolina as an example, we dissect the economic and legal implications of these laws, exploring the ambiguities in terms like "unreasonably excessive" and the chilling effect on commerce. Discover how artificially low prices can lead to resource misallocation, discourage stockpiling, and hinder the transportation of vital supplies during crises. Allowing higher prices is, perhaps surprisingly, the only way to get low prices soon. 

Links on Price Gouging:
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Book o'da Week:  https://www.simonandschuster.com/books/What-Went-Wrong-with-Capitalism/Ruchir-Sharma/9781668008263

If you have questions or comments, or want to suggest a future topic, email the show at taitc.email@gmail.com !


You can follow Mike Munger on Twitter at @mungowitz


Speaker 1:

This is Mike Munger, the knower of important things from Duke University back at the beach where I belong Prices and the cost of distorting prices. What is this gouging thing? A new twedge book of the week plus this week's new letter and more Straight out of Creedmoor. This is Tidy C. I thought they'd talk about a system where there were no transaction costs. It's an imaginary system. There always are transaction costs. When it is costly to transact, institutions matter and it is costly to transact.

Speaker 1:

Price gouging is defined as charging a high price for something consumers really need in an emergency situation. Now some people would just think of the prices of beer at an NFL game, say at Oakland's Alameda Coliseum back when they used to play there. I realize they're in Las Vegas now, but those are the numbers that I have. Apparently they were trying to make up for the fact that they were losing money by charging $10.75 for a 12-ounce beer. Popcorn at movies is often $12, $15 for a large. Now that seems like gouging because it's a high price and I don't like it. But those are just local monopoly prices for non-essential items, although for some of you probably beer at a football game. Well, real price gouging is often illegal. So anti-price gouging laws have three parts the trigger, the domain and the limit. So here's the part of the statute from my home state, north Carolina.

Speaker 1:

Upon a triggering event, it is prohibited for any person to sell or rent or offer to sell or rent any goods or services which are consumed or used as a direct result of an emergency, or which are consumed or used to preserve, protect or sustain life, health, safety or economic well-being of persons or their property, with the knowledge and intent to charge a price that is unreasonably excessive under the circumstances. So it's prohibited for any person to sell or rent goods or services used as a result of an emergency with intent to charge a price that is unreasonably excessive under the circumstances. In this case, the trigger is the declaration of a state of emergency by the governor or some abnormal market disruption, according to the statute. So this could be caused by a natural disaster, weather acts of nature. Any of those are a trigger the response of a state of emergency by the governor or an abnormal market disruption that causes an extreme shortage.

Speaker 1:

The domain, as you can hear from the text of the law, is stuff you really need Now I'm paraphrasing, but anything that you really need. So if you charge a high price for ice, the kind not the kind of ice that my wife likes to wear around her neck, but the kind of ice that you need when your freezer is thawing because the power is out. Well, that leaves the limit. If the law is triggered, and for commodities or services in the domain, how much can sellers raise price in the face of scarcity? And I already read it, but I want to make sure you caught it Sellers can't charge a price that is unreasonably excessive under the circumstances. So the price can be unreasonable, it can even be excessive, but it cannot be unreasonably excessive. Now I'm joking, but that's literally what the law says. That's not clear at all. That means that oftentimes people are not sure if they're violating the law or not. Now, apparently, the concrete interpretation of that phrase is 5%, perhaps 10%, depending on the circumstances. But if it's difficult for you to tell whether you're breaking the law or not, you're probably going to try to keep price even lower, which means that the law has a chilling effect on commerce. If it were clear, it would help. It would still be dumb, but it would help.

Speaker 1:

There are 34 states with anti-price gouging laws. A few others have statutes that can be used that way. Now there are three problems with anti-price gouging laws. First is misallocation. You walk into a store. The price is low. That says, take all you want, there's plenty. You walk into a store and the price is high. It says there's not enough, leave some for the person behind you. So if we have laws that keep prices artificially low, it makes people more selfish than they need to be.

Speaker 1:

I would like for people to have a reason to take account of the needs of others, and that's what high prices do. Second, high prices are likely to encourage stockpiling beforehand. So if you have an anti-price gouging law that will discourage stockpiling beforehand Say, there's a hurricane coming, you know people are really going to want milk or bread or other staples Stores could fill up their warehouses with needed supplies. That's expensive. Sometimes the hurricane passes without doing any damage. Changes course. The sellers could end up with a lot of wasted stock. So they're taking a risk With anti-price gouging laws.

Speaker 1:

There's no advantage to stockpiling because you can sell things at the regular price anywhere, and so stockpiling, which would really benefit people, is discouraged by anti-price gouging laws. Third, it discourages new supplies afterwards. What I mean is, if you have an anti-price gouging law. It keeps the price low even though you don't have enough of that stuff. So I can sell milk ice whatever people need in my store in Asheville, or I can hurriedly transport it to Raleigh, where it's desperately needed, and sell it for the same price. Who's going to do that? The only way I'm going to try to take things where they're needed is if the price is higher. It provides both a signal and an incentive. Anti-price gouging laws block that and they make it much harder to secure the new supplies that people need. The hard thing for most people to understand is that the only way to get plentiful supply at low prices is to allow high prices. High prices are a signal that more is needed and that people serving that desperate demand can be paid enough to make it worthwhile. But anti-price gouging laws raise transaction costs by blocking this information signal as effectively as an enemy army might lay siege to a city.

Speaker 1:

I want you to think about two people. We'll call them person A and person B. Person A learns that there has been a hurricane on the coast of North Carolina and says that's really terrible. I feel awful for those people. Someone should do something. Or person B, who says holy cow, they really need ice. I'm going to go and rent a truck, buy all the ice I can find and take it to the beleaguered city on the coast. When they get there, of course they charge a high price, because that's the reason that they were going. But people have ice that they're able to buy which otherwise they wouldn't have been able to purchase at all. Now, which one of those two people should we put in jail? Remember A does nothing, although they do feel bad. B sees a profit opportunity and does that which a omniscient, benevolent dictator would whisper in your ear take ICE to the coast where they need it. Well, we put person B in jail because we have anti-price gouging laws.

Speaker 1:

The grave difficulty that anti-price gouging laws cause is a confusion between three states of the world. First, everybody can buy everything they need at the price of that was apparently given to us by God a week ago. Second, we can keep the price where it was a week ago, but given that there is a shortage, there won't be enough and we'll have empty shelves. Third, we can allow prices to carry out two functions. First, help with allocation. If the price goes up, people who don't need to fill up their grocery baskets will only take what they actually need and leave some for the people behind them, and people far away will be given both a signal and an incentive to transport the needed material to the place that needs it. So the problem is the information signal is being suppressed in two ways. Anti-price gouging laws say we won't let prices signal the information that people need this. Leave some for the person behind you, and we won't let prices signal people need this. If you have extra in your city 200 miles away, get it on a truck and get it there as fast as you can, because if you do that, the shelves will not be empty. So really, the only choice is between the second and third alternatives. Do we want low prices and empty shelves, or high prices and the promise that soon there will be more of the stuff that we really need? Whoa, that sound means it's time for the twedge. This, in my opinion, is the best all-time price gouging joke and it's an economic insight.

Speaker 1:

This is a story that I've heard told about North Carolina, but it may have originated somewhere else. If someone else has heard it, I'd be interested to know. There's been a hurricane and people are desperately searching for things that they need. The owner of a convenience store has set aside some cases of bottled water in advance, knowing that people would need it. He knew the storm was coming and so he filled up his storerooms with as many cases of bottled water as he could get. Now he puts out the cases of bottled water and they're $40. So 24 plastic bottles of drinking water for $40, which is quite expensive. Customer comes in immediately, becomes angry and complains you know, the price down the street is only $12 per case. Why are you price gouging? The owner is puzzled Well, that's fine, why don't you go buy your water down there? It's up to you. Customer says well, they're out, the shelves are empty, but their price is $12. You shouldn't be charging $40. The owner says oh, oh, I see, I tell you what. As soon as I run out, I promise I'll drop my price to $10. Even lower Deal this week's letter.

Speaker 1:

Hi, professor Munger, I recently listened to your podcast where you discussed the idea that every house is an affordable house, and I wanted to share some thoughts. First, square foot per capita. One important aspect is the amount of square footage per capita in the US over time, which also holds true in Canada. You look at the data, you'll notice that square footage per capita has remained relatively stable, if not increased, over time. This suggests we don't necessarily have a shortage of housing in terms of square footage per person. What we have is a distribution problem. This could be a result of transactions costs related to distribution. A distribution problem. This could be a result of transactions costs related to distribution. Additionally, this trend implies an increase in empty rooms as household sizes shrink, meaning the number of people, whereas the houses, over time, have grown. The issue lies in the mismatch between supply and demand distribution, rather than a true housing shortage.

Speaker 1:

Second, shared equity loans or mortgages. I'd like to highlight the impact of mortgage costs and interest rates. One potential solution to the housing affordability crisis, which has been applied by Freddie Mac and Fannie Mae, is shared equity loans. With these loans, a bank or individual lends money to a home buyer, home owner without requiring monthly payments on the loan, but they retain an option for a percentage of the proceeds from the home's eventual sale. For instance, if a bank loans 80% of the property's value and the property is sold 10 years later, the lender receives 80% of the sale proceeds. This arrangement allows the homebuyer to benefit from property appreciation without bearing the full burden of ongoing costs, while the lender benefits from the reduced transaction cost and shared appreciation.

Speaker 1:

Third, I have a proposal for a citizen dividend through a land tax. I'd like to discuss the idea of shifting the tax burden from income something society generally wants to encourage where taxes discourage it to land, a resource that's fixed and cannot be easily manipulated. This is a Georgist approach where a land tax, say 1% per year, is applied to all land. Such a tax would discourage hoarding and underdevelopment of land. The revenue from this land tax could then be returned to citizens where it's collected. For example, if a municipality imposes the land tax, the proceeds could be distributed as credits to all residents, which could be spent locally, potentially with geofencing, like in the Wurgel experiment in Austria or similar experiments in South Korea. This could result in something like a $400 credit card that has a balance reset every month. Jurisdiction could even sweeten the deal by allowing citizens to pay off the credit card early and have an increased limit in the $800 in the following month, with maximum forgiveness capping out at $400 a month.

Speaker 1:

I'd be interested to hear your thoughts on these ideas to properly frame the housing shortage in quotation marks and ideas to potentially reduce monthly transaction cost of ownership. Cheers SJ. Well, thanks, sj. I don't have much to say about the Georges proposal. Thomas Paine proposed something very like this a land rent in the late 18th century.

Speaker 1:

There are a lot of Georges proposals like this and they're certainly interesting. It is a way of generating something like a universal basic income for people who live in towns that have this system. It's a complicated issue. I'm not going to say much more about it. What I thought was interesting is your proposal that we need some way of commodifying excess capacity. That's something that I've been interested in for a long time. So a homeowner might have a considerable amount of extra space, but it is difficult to find a way for other people to use it, and that's one of the things, of course, that Airbnb is so good at is the commodification of excess capacity. So if I were able to rent out portions of my house and do it in a way that were convenient and safe, that solved the problems of triangulation, transfer and trust, we probably could solve some part of the housing shortage, and I'm using the word, as you did, with quotation marks.

Speaker 1:

The problem, of course, is that the housing shortage is, in part, caused precisely by the fact that many cities and other jurisdictions will not allow rental of part of a house. They won't allow rental of a room. So the first thing that we need to do is get rid of the restrictions that make it illegal to commodify excess capacity. It used to be. The size of apartments was very small, they didn't have a bathroom, they didn't have a kitchen, it was basically a room, and if you're poor and you can get something like that for $30 a night, that's not bad. That's better than sleeping out on the street. But those are explicitly illegal, and so the difficult thing is, the commodification of excess capacity on all sorts of margins is being blocked by laws, and so making it possible for people to make more efficient use of their existing space would be a big step toward reducing the housing shortage.

Speaker 1:

The book of the week this week is by Ruchir Sharma what Went Wrong with Capitalism, published by Simon Schuster in 2024. I want to hate this book. I still actually want to hate it, but I can't because I think it's right. The argument goes like this Analysts, pundits, government officials, even more many people in the industry, have embraced a false narrative which claims that deregulation and shrinking government have caused instability in capitalism.

Speaker 1:

Now it is true that capitalism has become unstable, but regulations have expanded, not shrunk. The size of government has consistently grown. Size of government spending is just monotonically increasing. That narrative is simply false. However, that's the story that people tell themselves. Second, it really is true that giant corporations dominate the economy. This process is accelerating. The total stock valuations are at unprecedented heights, ceo pay and compensation for Wall Street operatives are shockingly high. But remember, the standard narrative says government's been shrinking. So the solution is we need to make government big again. But that narrative is false. The real explanation is an asset inflation or financial bubble caused by excessive government spending, expanding debt, profligate expansion of the money supply and excessive regulation that makes it difficult for small or new firms to enter, thereby insuring and protecting the profits of the large incumbents. Third part of Sharma's argument is the conflict between the standard narrative and the truth is going to cause a cataclysmic showdown between pretense and reality. If, as our leaders say and our young people are convinced, the problem is an unwise shrinking of government, well the answer must be larger government, and fast. That's wrong, but still the cataclysm is going to be caused by the collision between the grossly inflated values of financial assets and derivatives whose value depend on those assets, and the mistaken prescription that the solution is even more spending and more regulation. That correction, when it comes, is going to be devastating.

Speaker 1:

So, as I said, I wanted to hate this book. I just couldn't. The next episode will be released on Tuesday, august 27th. We'll have a new topic, some letters and, of course, a hilarious new twedge. And I should note, next week, on the 27th, is the last week in August, which means that I'll go to the school year schedule, one podcast per month rather than one per week. We'll have an interview with someone interesting and I'll learn a lot from the conversation. All that and more for one more week here on Tidy C.