Free Markets and Gouging

Great Debates
1

The heads of major cell phone service providers recently testified before congress regarding their fees for text messaging service. My own service provider charges ten cents per text message. If you think about it, this is a HUGE profit margin: a text message is generally less than 100 characters - 100 bytes - which is a tiny fraction of the size of a digitized voice conversation, and so requires far less bandwidth on their network. The margins are so large that there are accusations of “gouging” being flung around.

My own take is that the problem is lazy consumers who don’t want to shop around for cheap text messaging; they (the lazy consumers) just aren’t willing to do the shopping around (or simply abstain from using text messaging at all) required to make the service providers compete on price.

Whadday think? Should the government put a cap on text message service prices, or should we let the free market prevail?

Let’s push it even further:
You’re standing in the deep south staring at the aftermath of Katrina, in which there are widespread, prolonged power outages. portable generators are suddenly in heavy demand, and as they grow scarce, stores start charging double, triple, quadruple the usual price. In some states this is in fact a felony, but the hard-core lassez-faire capitalist believe that the high prices will rapidly attract more goods to the area to help satisfy demand, and that artificially holding the prices below what the market will bear will only result in an unchanging supply.

This seems to make some sense: if $1000 generators are suddenly selling for $4000 but local supplies are used up, any enterprising fellow can rent a U-haul; drive to the next state; pick up a dozen generators for $1000; and come home to sell them out the back of his truck for $4000. Presto: more local folks now have the generators they wanted. But if prices are held by fiat to the pre-disaster $1000, this ain’t gonna happen; folks will simply be stuck waiting for the next scheduled truckload of generators to arrive at the local Home Depot late next week.

So in the aftermath of disasters like this, do you think “gouging” should be legal, or are the laws against it a good idea?

2

For something like text messaging, unless there is some sort of bait and switch going on, or onerous cancellation fees, the gov’t needs to stay out.

Disaster gouging is a little trickier. I recall a story about a particular grocery store up in Rochester, NY during the famed Ice Storm of 1991 charging ridiculous amounts of money for batteries. At first blush, I was really pissed, you’re taking advantage of people. On second thought, if batteries are $10 for 4, the first people to the store aren’t going to buy up 10 packs and leave nothing for anybody else who might really, really, really need batteries. Yep, the batteries are expensive, but it’s much more likely that they will be there when you go shopping.

For me, I’d rather overpay for something I need, than have it entirely unavailable. If the store doesn’t have any, who cares what the price was?

3

Think about what would happen in a disaster area if people weren’t allowed to charge more for essential goods and services:

  1. There would be no added incentive to import more of the necessary products
  2. You would find there is an almost immediate shortage of these necessary pieces of equipment.

‘Gouging’ is a good thing. Gouging ensures that the people who need the product the most can get it. Take generators. Maybe you’ve already got one, but you’re thinking, ‘well, maybe I’ll buy a backup’. The price hasn’t changed, so you buy a second generator. In the meantime, the person with the fridge full of perishable medicines and baby formula now can’t buy a generator at all. And since the cost of providing generators to a disaster area is higher than it was before, yet the selling price cannot be raising, the supply of new generators will actually decline.

So you have people who needed a generator so badly they’d gladly pay 10x the amount for one not being able to find one at all, because people who have a much lower need bought them all.

Allowing the price of generators to rise to the market clearing price makes the market more efficient, and ensures that the limited supply of generators goes to the people who value them the most. The high profits available for the sale of generators causes the supply to increase as fast as possible, which is also what you want. This efficient allocation is even more important in a disaster area than in normal market conditions. There have been disasters where people have loaded their pickup trucks full of generators and driven into the disaster area to sell them to make a buck. High profits lead to big incentives to increase supply to meet demand, which is exactly what you want.

So what happens if you don’t allow prices to rise? You get a black market, because the demand is still there. But black markets are hard to deal with, hard for people to find, and introduce criminal elements and fraud. Much better to keep the market aboveboard.

The other thing that can happen is that the government seizes the goods and decides to ration them out. So now you have a bureaucrat who knows nothing about your personal situation deciding whether or not you should have a generator. And there’s even less incentive for new generators to be brought into the region.

Ticket scalping serves a similar purpose. It’s actually a good thing. Tickets are sold at fixed prices, but there are wide discrepancies in how much people value those tickets. At a fixed price, the person who has been waiting his whole life to see his favorite band might not find a ticket, because it was purchased by someone who decided to go on a whim and who really doesn’t care a whole lot. So scalpers buy up tickets, then allow people to bid for them. This ensures that the people who value the tickets the most can find them, and the scalpers absorb the risk that the tickets won’t be sold, which gives the venue more stability in ticket sales.

Someday, I wouldn’t be surprised if auction sites like eBay become the way that people buy and sell many goods of fixed quantity. If I were eBay, I’d try to figure out ways to streamline auctions from disaster areas, so people with extra goods can get them online and make money from them, and people who desperately need those goods can find them and buy them. Likewise, it would be an interesting experiment for a concert venue to make all its tickets available through auction. Organize them by seating section, and allow people to bid. They’d fill the house, extract maximum dollar for the best seats, and people would have to line up for two days to get good seats for their favorite band.

As for the cell network, the complication there is that many of them are given monopolies by the government, which gives them the power to screw consumers without much repercussion. So I wouldn’t want to say one way or the other what their pricing model should be without knowing more about their overall profitability and the nature of their market monopoly if they have one.

4

As a general guideline, allow gouging for luxuries but not for necessities. For the price of electricity, for example, allowing producers to charge anything is a recipe for disaster. As much was shown eight years ago in California. Following deregulation, California’s utilities were required to purchase electricity on the open market. Price caps were eliminated, and producers within or outside the state could charge whatever they pleased. As a result, they jacked up their prices by several orders of magnitude. Since for most people living without electricity for a long time is not an option, they had no choice but to pay those outrageous prices.

Meanwhile, cities such as Los Angeles that had maintained their public electric utilities still had all the electricity they needed. There was no shortage of electricity, there was only price-gouging.

With text messages, by contrast, no one needs them. People who really want them are free to shop around. If they’re really too lazy to shop around then they reap what they sow.

(Of course this leaves open the question of how to define price-gouging exactly, which I won’t tackle here.)

5

Umm, I assume you mean no economic incentive. Not that this really undermines your point. In fact government meddling can be just as discouraging to humanitarian endeavours as to capitalistic ones, but still… Unless you like the public image of conservatives as having no interest or understanding of anything but money, you really should be more careful. :slight_smile:

6

The economic issue with gouging in disaster areas is that well-functioning competitive markets can’t be said to exist. Case in point: even if you allow price gouging, you inevitably still end up with shortages of all sorts. Disasters tend to happen on a much shorter timescale than it takes for markets to react to them.

People, anticipating shortages, will look at the item for sale and not know whether they’ll have the opportunity to buy it someplace else. (If you have a functioning market, it’s irrational for people to expect a shortage–which is evidence against a functioning market.) Since for all they know the supplier will be the last one with clean drinking water for sale in town, that gives the seller monopoly power over consumers, which allows for exploitation and explains the increased prices.

Of course, at the same time there will be a real increase in demand. But it’s hard to separate that out from the market failure aspect of it. There’s no reason to think that the change in price due to price gouging PG is any more economically rational than PG/2.

As for SMS, the issue isn’t so much about whether it’s a luxury. The issue is that there’s no reason to think that there’s any market failure involved. I don’t know of how the costs of SMS work out, but if it were possible I’m sure some enterprising company would take advantage of the situation if there were actual overcharging.

7

AIUI, the problem with things like utilities and phone companies is that there’s a significant barrier to entry into those markets - either in terms of infrastructure (cell phone towers) or legalities (owning/renting the rights to airwaves). So even if I could make a profit selling text messages at 3 cents each, I’d have to have massive capital to start doing so. So, no new companies competing with the established players, and very little competition.

8 
Gouging ensures that the person who can pay the most will get the product. This is not necessarily the person who needs it the most. In your example a rich person who needs a second generator could easily outbid a poor person who needs it store medicines.

And this scenario is quite relevant in real-world disasters as well. Amartya Sen won the Nobel Prize partly for his empirical work on famines and his main discovery was that famines often occurred not because of huge declines in food production but because of declines in purchasing power of very poor people. So suppose the food supply declines by 5%. It would be perfectly possible for everyone to survive by cutting food consumption by 5%. But what’s tends to happen is that 19 people consume the same amount of food and the 20th person starves to death. The reduced supply leads to big spikes in food (often exacerbated by hoarding) and the very poor are simply priced out of their existence. I think most people would accept a big role for government in such situations: both in directly providing food for the poor and if necessary rationing the reduced amount of food.

As for the mobile phone industry it’s usually a fairly restricted oligopoly in most countries with a handful of big firms. In both theory and practice it’s hard to predict what happens in such markets. You could have intense competition and price wars or you could have cozy arrangements where the firms implicitly collude with each other to keep prices high. The latter is probably happening when it comes to SMS prices and there may be a role for regulators in pushing prices down.

9

It’s not clear to me that this is worse than ensuring that the person who shows up first will get the product. Neither can guarantee that the person who needs it most will get it. I think gouging does a better job of managing critical products so that Richie Rich doesn’t buy up all the stock “just in case”.

10

It’s hilarious that anyone who proposes price caps, rent controls, etc never volunteer to also have their wages/salary capped by the government. Why is that?

In looking at the state of the world, it is my opinion that Joe Frickin Friday makes too much money and society should cap his wages to $6.00-per-hour. That way, the money that society spent toward his salary could be better put to use such as state parks, school for the blind, feed the poor, etc. It’s a win-win for us all. Whadday say?

11

Or more hilarious, the notion that government needs to get involved to protect consumers from products and services that didn’t even exist 20 years ago, but now everyone feels they are entitled to at low, low prices.

One would think that is evidence enough, on its face, about the foolishness of interfering in free markets. The free market is what enabled those technologies to come into the mainstream in the first place. But now, of course, they need to be regulated for the ‘protection’ of the consumer.

12

Foolishness of interfering in free markets? Were you in a coma the last few years? The free market has merely destroyed the world economy. Now, who would want to prevent that ? One of the reasons we have a government is to protect the people and the economy from the ravages of the owner class.

13

I half remember a news item from several years ago where there was some flooding around southern Mississippi. IIRC home generators that cost $500 were being sold for $5000, and this made the evening news. The next day every guy in the southeast who had a pickup truck went to Home Depot, bought as many generators as he could, and took off for the flooded area. Within a day the supply of generators was OK and the price had stabilized.

14

It’s easy to say stuff like this without any proof. OTOH there are so many examples of the correlation between government control and poverty that it’s hard to know where to start.

OK…not that hard…I’ll start with North Korea. Big planned economy = big starvation.

15

Ability to pay is somehow related to need. The more I need something the more I am willing and able to pay for it. Price caps on goods and services inevitably lead to shortages and black markets.

Suppose the government says the hardware store cannot sell the generator for more than X. So I, who do not really need the generator that much, go out and buy it knowing I am getting something for less than it is worth right now. It is a good investment. Is the government also going to dictate for how much I can sell it now? For how much I can rent it? There is no way to control this. It just leads to bad economy.

You could argue that the ability of rich people to pay more than poor people makes prices go up and many poor people have to do without this or that. Yes, having money makes getting things easier, in good times and in bad times. That is the whole purpose of making money. Otherwise it makes sense to be poor and let the government take care of you.

16

For the most part we accept the price mechanism as an efficient and reasonably fair method of allocating resources. However the market for essential goods during emergencies is not one of them. The ability to pay is too weak a proxy for need to be useful. In that situation the government has to step in and temporarily suspend the price mechanism, implement some kind of rationing scheme as well as augment the available supply. The goal should be to ensure that whatever essential goods are available are distributed as fairly as possible with the government having to decide what that means. Otherwise we get into the world of the famines that Sen examined where the price of food spikes, those who can afford it buy it at that price and the poor just starve to death. When normal conditions resume, market mechanisms can be restored.

17

Take a look at financial snapshots of AT&T and Verizon.

AT&T has a profit of $12 billion on revenue of $141 billion. Sounds like a lot, yes? However, AT&T also has $60+ billion in debt. And their 3G wireless infrastructure is old and slow. They have to spend billions more to upgrade it to stay competitive with Verizon. They may possibly take on even more debt to do this. The high SMS prices may help fund this future expansion; or it may be helping pay back previous projects (that we don’t even know about) that had very little return on investment. Who knows what’s actually happening? To just throw out “collusion” as a single talking point is misleading.

It makes no sense for us to be judge & jury and declare that the cellphone companies’ SMS prices are unfair. You can simply choose to not pay for their service. I choose not to send SMS messages and likewise, I do not pay for it. If you want to go beyond that and don’t even want to pay cell phone prices because their basic voice plans are too high, then get a landline – or use 2 tin cans and a piece of string. The choice is up to you.

I read corporate 10k reports and I can’t tell if AT&T is gouging. Maybe they are – I dunno. How do all these other people come to that conclusion so easily? Their financial acumen is impressive.

I believe everybody’s salary that’s above and beyond the cost of gas to commute to work and the calorie needs met by canned soup is gouging the rest of us. What do we propose we should do about it to make things more “fair”? All of the “excess” money could certainly do the world a lot more good. What? No volunteers!!! I wonder why…

18

How do you do that? Do you have access to a vast fortune? If so I could see this would enable you to, but this isn’t the case for most people. The working class for example. A lot of hard working people do the jobs no one else wants to do for piddly wages. Jobs vital to society as any other. Though hardworking, they don’t make as much money as lawyers.

Your argument seems to be “it should be easier to be rich so everyone will want to be rich”. I find the idea of a society of Rand Rovers wanting. Even then society gives people different hands of cards. Studies show success is greatly influenced by being born into the right circumstances.

Consider a milk shortage. Is it right the baby of a poor person has to do without because milk is $30 a gallon and all the rich people are buying it for their cereal? Is this optimal?

19

I get unlimited texts and emails for $10. Unless a provider has a monopoly over an area, if someone is getting gauged on txts it’s their own fault.

20

Plan B, I wouldn’t waste my time if I were you.

Or, if you’re really interested in carrying this further, you could ask your SDMB foil how a voluntary transaction between two parties, with their own capital at risk, caused the world’s financial crisis.

Hint: It didn’t. That’s why the recent collapse of VC and hedge funds largely was confined to their own shareholders and principals.

Fiat money and credit expansion controlled by central banks, fractional reserve banking, and the socialization of lending losses via government backing (and taxation) is how a voluntary transaction between mortgage banker A and homeowner B affected Straight Dope Message Poster C.

All of those things are either (1) created by (2) managed and overseen by or (3) resolved by government action and use of force. The financial sector is about as far from a ‘free market’ as one can get in modern G-8 economies.

But like I said, I wouldn’t waste your time.