Here comes the price gouging...

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The gulf coast disaster has created a serious oil shortage, and right on cue politicians are complaining about price gouging. This Chicago Sun-Times article is a particular beauty:
Cars with Illinois plates had been lined up three deep at the pumps, sucking up Indiana gas at $2.69 per gallon, but overnight, the price shot up 50 cents a gallon.

"No lines today," Chris Patterson said Wednesday.

Regular unleaded at his Hammond, Ind., Marathon station two blocks from the Illinois state line cost $3.19. He blamed a new shipment that came in with a higher price.

"Everyone around us was running out of fuel last night," Patterson said. "We had people stacked up three to a pump."

Let's see. Before the price raise, gas stations were running out of gas. Afterwards, they're not. Look, it's the market in action.

Here's another classic. In the middle of an article complaining about prices, we get:

"If there is price gouging, it should be rooted out and punished," Blunt said. "Profiteering in a time of tragedy and crisis is both unconscionable and illegal."

Price hikes were evident at stations nationwide Wednesday as gasoline costs breached $3 a gallon in numerous states, the result of fuel pipeline shutdowns and delayed deliveries since Hurricane Katrina devastated Louisiana and Mississippi earlier this week.

Gas prices jumped by more than 50 cents a gallon Wednesday in Ohio, 40 cents in Georgia and 30 cents in Maine.

Concerns are now mounting over limited supplies of gasoline, including the possible return of long lines and scarcity reminiscent of the 1970s gas crisis.

In case it's not blindingly obvious, the cause of the long lines and scarcities of the 1970s gas crisis was price controls on gasoline.

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21 Comments

I think part of the frustration is the "Shoot up, leaf down" policy on gas prices: any increase doesnt' seem to have a pipeline delay, but decreases are slow and pipelined. Very obnoxiously, too.

Also, eg, CA is supposed to be an isolated market. We have our own "special" refineries, we get our oil from different sources (local, Alaska, and central/south america and middle east), etc... Then how come our costs have shot up too? Not quite as much, mind you, but still by a non-trivial amount in the past week.

What I find most interesting about the "price gouging" rhetoric this time around is its bipartisanship. The Democrats used to be the party of economic populism, but these days one is more likely to hear the economic arguments against "price gouging" complaints from liberal Democrats. I even heard them today on NPR's "Marketplace" show this afternoon.

This is all Econ 101. It's also important to remember Econ 201.

Even though many people sort of understand about price and demand, they can't overcome their emotional reaction that high prices in this particular instance place an "unfair" burden on people that can "afford" it least.

In these cases, I like to point out that temporarily increasing taxes on gasoline and then giving the proceeds to the most "burdened" victims is far more economically efficient than price controls.

The market still clears efficiently but it feels more "fair" because it appears to be helping those in need. It doesn't hurt the spin that the oil companies probably won't increase their profits as much. Anything that hurts the oil companies is always good for a bit of demagoguery. But at least this approach hurts them efficiently ;-)

Nick,

I'm trying to understand what you're getting at here...

Without going into the details of the cost structure of gas/oil companies, it seems to me that there are two basic situations in non-shortage situations: gas/oil companies have the kind of monopoly power required to extract monopoly rents or they don't. If the former, then why would they bother to wait for shortages to jack up prices? Why not do it immediately?

Dan,

While I would agree with your characterization of Mark Kleiman as a liberal democrat, he's also clearly someone with substantial economic training. In my experience, such people are in general against the sort of economic populism that underlies resistance to "price gouging" or free trade. I'm not sure things have changed much on this front.

Whenever there is an event which results in a price rice (eg, global oil prices, a tosco fire), the prices shoot up immediately.

Whenever there is an event which lowers prices (tosco fixes their refinery, global oil prices drop), it takes weeks for the change to percolate through the pipeline.

Natural behavior, but very infuriating to consumers.

"Shoot up, leaf down".

Oh, why the behavior:

You have to price rise immediately, because your costs just went up (passed IMMEDIATELY from your supplier).

But your price drops back down, you only need to drop back when your competitor's prices have dropped, or when you want to gain a short term advantage over your competitors, thus the "Falling-leaf" on decreases.

It's perfectly natural and understandable behavior, but rather frustrating, and seems to be because the retail gas stations set the price in the end: They have to base price increases on supply price increases, but price decreases on very local competition (often the guy across the street).

We've seen it at the pump for years.

The price gouging rhetoric seems like just rhetoric to scare the gas station owners from increasing profit margins too much. The reality is that the gas station owners are in a bad position because of the short term volatility of gasoline future prices. Due to the method of gasoline order fullfillment and payment, gas stations have difficulty knowing how much they actually pay for gas before they've actually sold it! In a volatile market environment, this makes it difficult for a gas station owner to predict their costs and profit margins. Stabilization of the market will have a much greater impact on eliminating the risk of price gouging.

Kleinman is incorrect in his characterization of "market clearing" as "price gouging". Price gouging has a different definition in U.S. politics. The vast majority of US gas stations are prohibited, by law, from precipitously increasing their profit margins on gasoline during a crisis. "Shoot up, leaf down" is illegal unless the "leaf down" maintains stable profit margins on the costs paid to wholesale suppliers. Wholesale suppliers basically charge a price set in the futures market, which is as close to a competitive market as most economists could hope for.

So far, I think the government reacted well to the oil situation. The encouragement of the announcement of additional European gasoline supplies was especially helpful to combat rising fear in the futures markets.

Steve,

Do you have a reference to the regulations governing the prices gas stations can charge? It sounds like you're asserting that there are existing price controls.

I'd really like to know what you think the specific mechanism under current law is that prevents gas stations from setting their prices at the market clearing price.

The FTC oversees price gouging related to interstate commerce. The states have additional price gouging laws associated with the declaration of a state of emergency. Googling on FTC, DOE, gasoline and price gouging should get you overview information. How the FTC reviews the regional markets is outlined in the links from the DOE's gaswatch web site (http://gaswatch.energy.gov/). If you want the specifics of how they do it, you'll need to consult several of the FTC conferences and staff reports.

The FTC reviews gas pricing for anti-competitive collusive behavior and for unilateral action by a firm with market power. Horizontal agreement on gas prices would be an example of collusion and is illegal under federal antitrust law. Unilateral anti-competitive behavior by a firm with market power is investigated relative to zone pricing. When the DOE suspended emission differentiation across zones, they opened the door for the FTC to examine the use of price discriminition between zones by companies with market power.

The states have no uniform code. You'll need to examine each of their statutes for the specific information. Their laws merely complicate the intent of the federal law -- during an emergency, make it unattractive for gasoline suppliers and retailers to make unusually large increases in their profit margins. The politicians were careful not to implement price controls or mess with the market clearing price in the world market.

The actual results should be very nearly what most citizens expect: limitations on opportunistic price gouging during an emergency which are enforced through the hassle and bad press of price gouging investigations/charges. The limitations are not perfect or fixed, but can be exercised as the gravity of the situation requires it.

Hmm. I'm not sure this evidence supports your original posting. Most of the FTC regulations don't seem to apply to the individual gas station owners you cited in your first post. They seem to apply to wholesale prices. Not surprising given their jurisdiction is limited to interstate commerce.

Certainly, I couldn't find anything at the federal levels that would prevent an owner who believed his supply was very limited for the next month from charging whatever he thought would balance supply and demand.

As you say, the state level regulations are a patchwork. Though I couldn't find any regulations that specifically prohibit raising prices to balance supply and demand (though Hawaii appears to have outright price controls).

I agree that the threat of price gouging prosecution definitely has a deterrent effect. But in general, it looks like gas station owners are pretty much in the clear as long as they reasonably believe their prices balance supply and demand. Unless of course, an official state of emergency is declared and specific price controls are ordered.

The FTC oversight applies to any company that has intrastate market pricing power. So, it applies to companies that own gas stations in more than one state or to gas stations with prices influenced through contract by a company with pricing power in multiple states. This gets the big guys in the industry.

And the 48 cont. state laws/regs/etc. do not assert price controls. They generally have vague language around profit margins, which mimic the enforcement by the FTC as part of their consumer protection laws.

Example 1 Indiana statute: (http://www.in.gov/legislative/ic/code/title4/ar6/ch9.1.html)

Example 2, Illinois AG using consumer protection rulemaking authority: http://www.ag.state.il.us/pressroom/2005_09/20050902b.html

Example 3, PA AG working with FL AG and AL AG using consumer protection regs: http://www.attorneygeneral.gov/press/release.cfm?p=17C68AA4-09F6-F1BE-074B612051B9EF05

Example 4, MA consumer protection regs: http://www.ago.state.ma.us/sp.cfm?pageid=2179

The only gas station owner who is "in the clear" on price gouging is the true independent, small time player in a state with poor consumer protection laws, a weak AG, a weak gov, and a weak state assembly. Assuming, of course, that these small time players aren't the most easily influenced by local politics and fear of retribution for the perception of price gouging.

Steve, I don't understand your point. You write:
"Kleinman is incorrect in his characterization of "market clearing" as "price gouging". Price gouging has a different definition in U.S. politics. The vast majority of US gas stations are prohibited, by law, from precipitously increasing their profit margins on gasoline during a crisis. "Shoot up, leaf down" is illegal unless the "leaf down" maintains stable profit margins on the costs paid to wholesale suppliers."

But in conditions where demand would exceed supply at the current price (i.e. there are shortages) than the market clearing price is higher, regardless of the merchant's costs. Thus, there are situations in which the market clearing price would be labelled price gouging by your definition.

Actually Steve, you've made my point for me. I checked your fist two examples and they both only apply in a state of emeregncy. In the Indiana case, it's whenever the Governor declares a state of emergency. In the Illinois case, it's only for 150 days from Sep--this specific emergency.

Moreover, both cases have an out if your wholesale prices go up. Illinois has an additional out if general retail prices in a particular area go up. So presumably a general fairly slow increase in prices does not trigger this regulation.

Your 3rd and 4th examples aren't very specific: they're a press release and a FAQ. However, they seem to have the same "emergency" flavor with outs for higher wholesale or local retail prices.

So I can actually make my original statement stronger. Not only can a local gas station raise prices to balance demand in the absence of an emergency, he can also usually raise them during an emergency as long as he does so gradually and in line with what other local stations are doing,

I also have a creative out for the local gas station owner that wants to raise prices to balance demand. Declare that you will donate a certain number of cents per gallon to the relief effort, thus voluntarily driving up your costs.

EKR wrote, "in conditions where demand would exceed supply at the current price (i.e. there are shortages) than the market clearing price is higher, regardless of the merchant's costs. Thus, there are situations in which the market clearing price would be labelled price gouging by your definition."

--> I would need to see an example, but I would concede that it might be possible to place a gas station in such a position. However, the FTC uses a few days of data in its calculation, which makes this outcome even less likely, given the short range inventories of typical gas stations (under 5 days). And it is even less likely to be prosecuted.

Kevin, I don't really understand what you're arguing any more.

The current cries of price gouging by politicians are about invoking consumer protection laws to prevent retailers from taking higher profit margins during volatile futures prices. They are not designed to prevent retailers from gradually raising their prices. The US and state govts generally assumes that gas retailing is a competitive market and retailers behave as such. You seem to be suggesting that gas retailing is not a competitive market and retailers have unlimited pricing power.

Fuurther, politicians are talking about price gouging to encourage consumers to report it if they see it. If enough reports occur in a state then the govt will have evidence to support a move to declare an emergency. In an emergency, they will prosecute gas retailers that are extracting larger than normal profit margins.

The FTC has on-going management of the big players -- the multinationals and multistate providers. These players constantly are under scrutiny for abuse of market pricing power or collusion, without a state of emergency. The assumption is that if these big players price gas inline with regular profit margins then the competitive market will encourage other retailers to price competitively.

None of the laws (neither state or federal) prevent local gas stations from raising prices to balance demand. In fact, they encourage it! But they discourage retailers from profiteering from volatile markets. Sure, some profiteering can take place in the initial few days or even a week or so. But the laws are designed to throttle it. Without price controls.

Now I'm really confused about your point, Steve. The usual definition of price gouging--and the one which you appear to be using--is to price well above marginal cost. What keeps gas stations from raising their prices well above marginal cost in normal circumstances is competition from other gas stations in the area. The only way in which emergencies would affect that situation is to lower supply/raise demand to the point where all the gas stations in an area can still sell all of their gas at the higher price and therefore have no incentive to undercut each other. Is your claim that this is is unlikely because of low inventories? If so, what is the purpose of anti-price gouging regulation?

Rephrase this section so that I'm certain I understand your point: "The only way in which emergencies would affect that situation is to lower supply/raise demand to the point where all the gas stations in an area can still sell all of their gas at the higher price and therefore have no incentive to undercut each other."


My read of the legislation is that it is designed to let the spot/futures market drive the price for gasoline at the local retailer. The FTC attributes 85% of the price of gasoline to the broad market price and they wish to keep it like this.

What are we arguing about? Well, your general argument seems to be that the government has reacted well by crying "price gouging" and using the various laws at its disposal to restrict the free movement of prices.

In general, Eric and I are both arguing that it's bad policy to prevent a gas station owner from raising prices under a supply constriction so that the demand at the raised price equals the restricted supply. Such policies _cause_ rationing and shortages.

As you've cited, there are a number of laws that somewhat restrict a gas station owner's freedom of pricing. My counter argument is that they don't really restrict gas station owners from raising prices during a localized supply constriction to a level that layperson might call "gouging". The reference price of other gas stations in the same locality will reflect the local supply constriction.

Moreover, you seem to be mixing general government policy on gasoline pricing with specific policies being applied during this "crisis". The spot markets are not the problem and have no bearing on a gas station owner in Louisiana right now. As Eric and I are both pointing out, it's the logistical difficulties of delivering gasoline to specific locales that drive prices up in this type of crisis. Laypeople think this is gouging when it's really just the realities of local supply and demand.

That's a creative intrepretation of the discussion.

If you believe the current policy regime is bad policy, you should present evidence which argues against it. So far, you seem to be arguing against price controls as they existed in the 1970s. If such price controls existed, it might be an interesting discussion.

Eric's cites are for articles referring to gas prices across the United States and not Lousianna. The logistical difficulties of delivering gasoline to New York and Texas (two of the cites) are not causing increased prices in those states. The price is rising in New York specifically because of increasing gasoline prices on the spot and futures market.

In the current case of national gasoline pump prices, you are just dead wrong if you state that logistical difficulties of delivering gasoline explain the majority of the rise in prices in the northeast and west.

As you've presented no evidence that the current policy is a good idea, I don't feel compelled to present evidence to the contrary. Other than the Economics 101 arguments against price controls.

We may not have an argument at all. I'm saying price controls that cause a supply-demand imbalance are bad and that it doesn't seem to me that we have price controls that prevent a price rise by gas station owners in response to an emergency.

You asserted that we have at least the threat of price control through the anti gouging regulation. If you don't think these threats affect ability to price at the market clearing price for each individual locale, then we don't have any argument.

But your posts tend to bring a lot of information into the equation, not all of which appears directly relevant (at least to me) to the original blog post or subsequent comments. So it's hard to tell if you think we have an argument or not.

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