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By Robert Rapier on Sep 14, 2008 with no responses

Defining Price Gouging

As I warned yesterday, we may be on the verge of runaway gas prices in some areas. Today I spotted this story at CNN:

Complaints of rising gas prices as Ike hits

Some excerpts:

WASHINGTON (CNN) — President Bush Saturday said officials will ensure gasoline stations don’t gouge customers after Hurricane Ike, but with some prices near $5 a gallon, some consumers were not so sure.

Sean Kennedy, of Knoxville, Tennessee, took a photo of a Knoxville station displaying a $4.99 per gallon price for regular gasoline on Saturday. The previous day, he said, he had bought regular gas at the station for $3.59 a gallon. “I know the hurricane is causing a spike, but … [nearly] $1.50 in 24 hours?” Kennedy said.

The governors of Georgia, Louisiana and Florida said complaints of gouging would be investigated. Florida Gov. Charlie Crist said Friday that $5 a gallon “can only be described as unconscionable,” according to the AP.

“Raising rates to exorbitant levels like this only causes unnecessary panic and fear,” Crist said, according to the AP. “This type of behavior will not be tolerated.”

Here’s another from the AP:

Far from Ike’s path, an aftershock is felt: $5 gas

HOUSTON – From Florida to Tennessee, and all the way up to Connecticut, people far from Hurricane Ike’s destruction nonetheless felt one of its tell-tale aftershocks: gasoline prices that surged overnight — to nearly $5 a gallon in some places.

In Knoxville, Tenn., account executive Sharon Cawood said “one of our local gasoline chains called a local TV station Thursday, sometime during the day and said, ‘We’re running out of gas. We’re going up 80 cents a gallon… It caused a major scare.

In Florida, the attorney general’s office reported prices as high as $5.50 a gallon in Tallahassee and said it had received 186 gouging complaints.

What is Price Gouging?

This brings to mind the question, “What is price gouging?” In the past, I have written a number of articles on price gouging, mostly arguing that various accusations were groundless in the context of the particular supply/demand situation. From the perspective of a consumer or a government official, a knee jerk reaction to a sharp price rise may well be to conclude price gouging. But is it valid? Is a sharp price rise ever justified?

Much like the distinctions between various crimes, be it a debate on whether a death was murder, manslaughter, or just an unfortunate accident – my position on price gouging would come down to intent and motivation. If someone raises prices sharply because it looks like they will run out of gasoline supplies before their next delivery, I don’t believe that is price gouging. In other words, if the price rise is inventory driven, then it becomes much harder to argue that price gouging is taking place.

Raising prices in this sort of situation prolongs gasoline supplies, and ensures that those who desperately need gasoline can get it. Failure to raise prices in this sort of situation can mean that consumption will continue on as normal, which will run out supplies even more quickly. Or worse, if people think there are going to be gasoline shortages, and suppliers don’t raise prices (or ration), then they may find that hoarders run them out of gas even faster than normal. Given a choice, I think most people would prefer to have some gasoline at a much higher price rather than have prices stay low, but supplies run out.

On the other hand, let me describe a situation that I believe would qualify as price gouging. If a gasoline supplier has adequate supplies and there are no major concerns that they will run out of fuel – but they still sharply raise prices in the face of a crisis, then that would be price gouging in my opinion. In that situation, a person is not raising prices to protect their supplies, but instead to take financial advantage in an emergency situation.

So, how could one tell the difference? Unfortunately, it’s not black and white, but instead shades of gray. A person who is worried about falling inventories might be justified in raising prices by $1.00/gallon overnight, but what if they raised prices by $10/gallon overnight?

Or, say you had two gas stations across the street from each other, and both increased prices by $1.00/gal. In the first case, let’s say the owner has adequate inventories on hand, and no worries that he is going to run out. I would say that he is taking advantage. In the second case, if the owner is running low on inventories and is concerned about running out (because he gets his supplies from a refinery that has been negatively impacted), then I would say his price increase is justified.

But you can’t tell just by looking. You might think a sharp price rise is unjustified, but you can’t really know for sure unless you have more facts at your disposal. Simply put, my definition of price gouging is “attempting to take financial advantage by raising prices in an emergency.” If you raise prices to protect your inventories, then I wouldn’t necessarily conclude that there was price-gouging taking place. For me it all boils down to intent and motivation (and of course those can be difficult to pin down).