Price gouging laws sound fair and then the shelves go empty

A hurricane has just come ashore. The power is out across three counties and will be for a week. A man pulls into a gas station parking lot, finds a pallet of bagged ice, and sees the sign: triple the usual price. His blood pressure rises. He has a freezer full of food and a family to feed, and some stranger is "profiting from misery." Every instinct he has says this is wrong, and every politician in the state agrees with him.

I understand that reaction, and I want you to know I respect the instinct behind it. It comes from decency. It comes from a belief that when disaster strikes, neighbors help neighbors and nobody should get rich off a family's worst week. Folks, I share that belief. But I want to ask you to hold the thought for the length of this post, because the policy that grows out of the instinct, a law that caps the price, has a record. And the record says that the law does not produce more ice. It produces an empty shelf and a long line of people holding money.

The case for the law, at its best

Let me state it the way a smart supporter of gouging laws would, because the argument deserves a fair hearing.

"In a disaster, the usual market conditions don't hold. Demand spikes, supply is cut off, and buyers have no alternatives. They can't drive to another county. They can't wait. A seller who raises prices in those conditions is exploiting a captive customer. The law doesn't ban profit. It says that after the governor declares an emergency, you can't raise prices far above their ordinary level. It protects the poor, who can't pay triple, from losing out to the rich, who can. And it reflects a basic moral sense, which people everywhere share, that it is wrong to take advantage of desperate people."

Most states have some version of such a law, typically triggered by an emergency declaration and a price increase above a stated percentage over the pre-emergency level. If you want the exact rule in your state, look at your attorney general's website or the state code on your legislature's website. The laws differ, and I'm not going to pretend that they are all alike.

Now the answer, in numbered points.

Point one: a price is a message, and the message is "bring more"

When the price of ice triples, that is not just a charge. It tells every person who could supply ice that there is a profit in doing so. It tells a distributor three states away to load a truck. It tells a trucker he can be paid enough to drive through the night. It tells a store manager to call in extra people. It tells a buyer to take one bag and not six, so that others can get one too. We covered this mechanism in I, Pencil and the price system, how nobody plans your breakfast: prices carry knowledge that no one can gather in one place.

Cap the price at its ordinary level and you have not changed the hurricane. You have turned off the signal. The ice that is already in the store sells out in the first hour to the first people in line. And the truck three states away stays parked, because the expense of the trip exceeds what the capped price will pay.

Let me show the arithmetic, with a hypothetical. These numbers are made up to make the point.

• A distributor three states away can buy 2,000 bags of ice at $1.50 each. That costs $3,000 (2,000 times $1.50).
• Hauling them overnight, with the driver's overtime and the fuel, costs $1,800.
• Total cost: $3,000 plus $1,800, which is $4,800.
• In the heat and the delays, a fifth of the bags melt on the way. That is 400 bags (2,000 times 0.20). Only 1,600 are left to sell.

What price does the distributor need just to break even? $4,800 divided by 1,600 bags is exactly $3.00 a bag.

Now suppose the ordinary price in the stricken town is $3.00 and the law caps the price at that level. The distributor would earn $4,800 from selling all 1,600 bags, the same as his cost, and he would earn nothing for the risk, the night's work and the chance that the road was closed and he sold nothing at all. So the truck stays home. At $4.50 a bag, the same 1,600 bags bring in $7,200 (1,600 times $4.50) and the distributor earns $2,400 above his cost. The truck rolls. Which town gets ice, the one with the cap or the one without? And which family would you rather be?

Point two: the cap doesn't ration fairly, it rations by line

Every price system rations. The question is how. A high price rations by willingness to pay. A capped price rations by something else: who got there first, who has the free time, who has a truck, who knows the store manager, who can stand in a line for four hours. The retiree and the single mother working a shift have no better chance in the line than they would have had with money, and often a worse one.

A capped price also encourages hoarding. When ice costs the same as it did before the storm, a family has every reason to buy six bags and fill the freezer, because it is cheap and may be gone tomorrow. When it costs triple, the family buys what it needs. The high price spreads a limited supply across more households. The cap sends it to the fastest.

Point three: Rome tried it and so did Washington

This isn't a theory that someone dreamed up. It is one of the oldest lessons in economics, and governments keep relearning it the hard way.

In the year 301, the Roman emperor Diocletian issued an Edict on Maximum Prices, which set ceilings on hundreds of goods and wages across the empire. The edict threatened severe penalties, up to death, for those who violated it. Historians generally describe it as a failure. Goods disappeared from the open market, trade went underground, and the edict was widely ignored and eventually left to die. The record of it is fragmentary, so I'll be careful about claims on details, but its failure is the standard example for a reason.

Fast-forward to August 15, 1971. President Richard Nixon announced a ninety-day freeze on wages and prices, part of a package that also closed the gold window. The freeze was popular at first. It was followed by a series of phases of controls that stretched on for years, and inflation did not go away. It came back, and in the 1970s it got worse. Many economists look back on the episode as a lesson in how controls can hide inflation for a while without curing it, and they lead to distortions when they are lifted.

Then came the gas lines. After the 1973 oil embargo and again in 1979, Americans sat for hours in lines at the pump. Federal price controls on oil and a system of government allocation contributed to the shortages, because they kept the price below what the market would have set and discouraged both production and the movement of fuel to where it was most needed. A government committee decided who got gasoline, and the committee was not good at it.

On January 28, 1981, President Reagan, in one of his first acts in office, ended the remaining federal controls on oil prices. The warning from the critics was that prices would spike and the poor would suffer. What followed is that the gas lines were gone. You can read the longer story in Eight Days Into His Term, Reagan Scrapped Oil Price Controls for Good. The lesson is not that decontrol is painless. It is that a shortage was a product of the policy, and removing the policy brought back the supply.

Point four: the guilty party is the storm, not the seller

The most powerful emotional force behind a gouging law is the image of the seller as the villain. But look at what the seller is. In a hurricane the one scarce thing is the product, and the person who gets it to you at any price is performing a service. The seller who raises his price is also taking a risk. If the storm turns and nobody buys, he is stuck. If he sells at a loss in normal times, nobody rushes to help him.

None of this means a seller who lies, or who threatens, or who takes advantage of a customer through fraud, should be left alone. A different category of conduct exists, and we will get to it. But a high price on its own is not a crime. It is an announcement that something is scarce.

Point five: the buyer's side of the ledger

The same hypothetical works from the shopper's side. Say a store has 600 bags on the pallet when the doors open, and the shelf price is the ordinary $3.00. Households panic a little, as households do, and each one grabs six bags to be safe. Six bags a household means the pallet serves 100 households (600 divided by 6), and the 101st family in line gets nothing. Many of those first 100 will not use all six. Some ice will sit in a garage and melt.

Now let the price float to $9.00, triple the ordinary price. A family that was going to grab six bags for $18 now thinks about it. Six bags at $9.00 is $54 (6 times $9.00). Most families decide that two bags, $18 in all, will cover the refrigerator and the cooler. If every household takes two, the same 600 bags serve 300 households (600 divided by 2). The high price did not make ice appear. It made the existing ice reach three times as many doors. That is a rationing job a state office could not do as well, because no clerk knows how much ice each household really needs. The household knows, and the price asks it a question.

None of this is cheerful for the family on a tight budget, and I will not pretend it is. It is the reason the answer in the next section is charity and targeted aid: help the family that cannot afford the bag, and leave the price alone so the truck keeps coming.

The fair alternatives

Here is the constructive part, because "do nothing" is not what I'm saying. If we care about the family that cannot pay triple, there are better tools than a price cap.

1. Charity and private giving. Churches, civic groups and neighbors show up after every disaster. A food bank or a church can give away ice and water to anyone who needs it, and nothing in a market stops it. This is where the generosity that gouging laws are meant to enforce actually works.
2. Targeted help. If the concern is that the poor cannot afford emergency supplies, the answer is to help the poor with money, vouchers or direct aid, not to freeze the price for everyone and ensure the product disappears.
3. Fraud enforcement. A seller who advertises a price and charges another, who sells a product that does not do what it claims, or who collects a deposit for a repair and vanishes is committing fraud, and fraud is already against the law. Attorneys general should go after it hard, and during disasters they do.
4. Clearing the way for supply. Governments can suspend rules that slow deliveries, such as weight limits and hours-of-service restrictions on trucks hauling supplies, and they can open roads quickly. The more suppliers can bring in, the lower the price falls on its own.
5. Transparent sales. Stores that choose to limit purchases per customer, or to hold prices steady, are free to do so as a business decision. If a store wants to build a reputation for treating its neighbors well, it can. The market rewards that, too.

What the other side gets right

I owe the supporters of these laws one concession. They are right that the moral intuition matters. A society where people are indifferent to price spikes in a disaster is not one I'd want to live in, and a store that treats a hurricane as a windfall will lose some customers for good. Reputation is a real force, and a seller who is remembered as the one who fleeced his town in its worst week pays for it later. I'd add that in a few narrow cases, such as a single seller with a lock on a small town's only supply of a vital product, the argument for some limit is stronger, and a reasonable person can differ.

But as a general policy for the whole economy, a price cap in a crisis trades a feeling of fairness for a smaller supply. That's a bad deal for exactly the people it promises to protect. For how rising prices land on three different households, read three households and one grocery bill, budget scenarios when prices jump. For the larger point that a market has a failure mode and so does a government, read Yes, Markets Sometimes Fail, and Governments Fail Right Alongside Them.

The bottom line

• A high price after a disaster tells suppliers where to go. A capped price tells them to stay home, and the shelves are the proof.
• If you want a fair outcome, give directly: donate, volunteer, and support charities that hand out supplies for free.
• Report real fraud, such as a bait-and-switch or a contractor who takes a deposit and disappears, to your state attorney general. That is a crime. A high price alone is not.
• Ask your legislators to clear the way for supply during emergencies: waive trucking limits, speed up permits for repairs and restore roads fast.
• Before you cheer for a price cap, ask what happens to the supply if the price is held down. History has answered that question for seventeen hundred years.