Opinion: Free Market Minute

Price Gouging: A Cure For Gas

It'll cost an eye, but save you a scarcity

Wrong-headed fear-mongering and price hysteria are counterproductive and harmful, no matter what the price of gas. But markets consist of both supply and demand, and prices are the result of market forces. There are some things that consumers are doing on the demand side of the market, and government is doing on the supply side, that promise to create additional problems with gasoline in the coming days and weeks or months.

Continued regulation of gas prices, specifically the threat of prosecution for price gouging at the pump, will very likely bring us to the point of more empty gas pumps, long gasoline lines, gas rationing, or some nightmare combination of the three. Keeping the pump price lower than it would otherwise be through these policies will also encourage non-essential driving, and discourage conservation. Price gouging, a term that has no economic meaning, is actually helpful in averting a gas crisis. Here’s why:

The current pump price of a gallon of gasoline is an indicator of how hard or easy it is for the supplier to replace the gallon sold today with a gallon for sale tomorrow. Regardless of the cost of refining gas in the past, it will cost significantly more to replace it today. Katrina destroyed refining capacity, and that will reduce supplies of domestically refined gasoline, and push up market-clearing level of price, at least temporarily.

At a high enough price, gas will always be available to those who need it most. But when gasoline is sold below its replacement cost, stations ‘run out,’ and gas is available only to the lucky. This might be fine for a lottery, not for a market.

Regulations that prohibit gasoline prices from reaching a market-clearing level will ensure that gas remains unduly scarce.

Replacement cost pricing is easy to understand in markets for collectibles. For example, a 1952 # 311 Topps Mickey Mantle Rookie card at last check, had a bid on E-Bay of $41,000, with several auction days remaining. In 1992, Sotheby’s auctioned a Mantle rookie card for over $46,0000—nearly $65,000 in today’s prices.

The original cost and price of the Mickey Mantle baseball cards, packaged with a slab of pink bubblegum? A few cents. Price gouging at the collector price (of the card)? Certainly not. An essential item? No, except in the minds of baseball memorabilia aficionados. Shortages, long lines, unserved but willing collectors? Remember, these are extremely rare items. But no, none of the above. These markets, like the one which delivered Babe Ruth’s 1931 bat to an ardent collector for $124,000, cleared perfectly because price rose high enough to eliminate all but the most serious contender.

The fact that high (enough) prices coordinate markets for ‘frivolous’ goods demonstrates why prices must adjust to reflect scarcity in basic goods, especially in times of disaster. Gasoline is a lifeline for some people. Those in need of regular medical care like dialysis, or emergency transport to hospital after accidents or life-threatening events like a stroke or a heart attack, won’t survive if vehicles are ‘grounded’ due to lack of gas. Police, Medevac and air ambulance are among the services we depend upon, but whose needs we cannot always predict. If gas is not available for these uses, because it has been hoarded and sold out at “non-gouging” prices, the neediest people will suffer the consequences.

Every time consumers ‘stock up’ on gas by increasing their average gasoline purchases, or hold gas reserves above their normal amounts, they increase the demand for gasoline and drive price up. Most don’t realize that their actions have a perverse effect on price. Prices aren’t ethical or unethical. If exchanges are voluntary, all pricing is fair.

The way to reduce the quantity of gasoline demanded in the near term is to allow price to rise to whatever the market will bear. This is not price gouging, it’s responsible reservation of a scarce good—like the reservation pricing we see in collectibles and other markets.

Only those with really urgent demands will pay the highest prices, as should be the case. The rest of us will conserve, and adjust for the future as the situation unfolds.