Prohibiting price increases during disasters good optics but bad economics

CleanShelf Supermarket was labelled unconscionable, usurious, and unethical for increasing hand sanitisers' prices

In Summary

• Price gouging is merely a reaction to supply and demand, and not greed or taking advantage of consumers during a crisis.

• After a natural disaster, the supply of certain items becomes constrained while their demand skyrockets. In a free-market economy, price gouging becomes a necessary adjustment because it helps to clear the market price.

A Cleanshelf store
A Cleanshelf store

After Hurricane Katrina, one entrepreneur from Kentucky was watching the news when he learned that those affected by the hurricane desperately needed generators.  The hurricane had knocked out all the power in the area.

So the entrepreneur bought several generators and drove almost 950 kilometers to this part of Mississippi State that had experienced the hurricane. The power blackout had left five million people without electricity. Upon arrival, the entrepreneur offered to sell the generators for twice the price he had bought them for. The people were eager and willing to buy the generators because he was supplying a product that was in great demand but unavailable.

The Mississippi police, however, refused to allow the entrepreneur to sell the generators at the price the consumers were willing to buy them. Instead, they confiscated the generators, and locked him up in jail. The public was very upset and demanded his release so that they could buy the generators from him. The State authorities declined to do so, terming his actions immoral.

Unconscionable; usurious; unethical.

These are some of the labels that were attributed to CleanShelf Supermarket in Nairobi, when it was discovered that they had increased the prices of hand sanitisers after its demand sharply rose following the advice to sanitise hands as a measure to protect against the coronavirus.

Subsequently, the Competition Authority of Kenya found that the retailer had contravened the Competition Act No. 12 of 2010. They ordered them to refund all their customers who had bought the sanitisers at an inflated cost. The supermarket in turn blamed one of its staff for arbitrarily adjusting the prices upwards without the consent of the retailer’s management.

In economic-speak, this is known as price gouging. It occurs when a seller increases the prices of goods or services to a level much higher than is considered reasonable or fair. It is triggered by demand or supply shock, particularly after a crisis such as a hurricane, earthquake, and in current times, the Covid-19 pandemic. Often times, it is considered exploitative and the sellers are regarded as unconscionable businessmen taking advantage of windfall profits.  

Begs the question, is price gouging always an immoral act? This is one of the areas where public opinion and economic sense always disagree.

I submit, however, that analysed purely from a praxeological economic perspective, price gouging is not unethical. Let me tell you why.

In simple economics 101, price gouging is merely a reaction to supply and demand, and not greed or taking advantage of consumers during a crisis. After a natural disaster, the supply of certain items becomes constrained while their demand skyrockets. In a free-market economy, price gouging becomes a necessary adjustment because it helps to clear the market price. Clearing the market price means the price at which the quantity demanded of a certain product or service, equals the quantity supplied, thus ensuring no surplus or shortage exists in the market. In other words, it is the price that corresponds to the point of intersection of the demand and supply curve.

When the demand for a commodity is high, it causes a domino effect along the supply chain and communicates that more is required. This is known as the bullwhip effect. Resultantly, production and supply of the commodity is increased. Increased demand leads to increased production, which leads to increased job creation, which in turn boosts the economy. Increased production also reduces the shortage in supply of the commodity that had triggered the price increase, thus normalising the price back to pre-disaster levels.

Second, when consumers realise that certain supplies will be limited, they rush to get what they can before it is finished. This often results in over-crowding and long lines. And in the context of Covid-19, this is counter-productive because it amplifies the health risk of transmission of the virus.

Therefore, price increases restrict the rush to overstock. Consumers economise and purchase only the quantities that they need. This reduces the unreasonable bulk purchases of sanitisers and disinfectants witnessed in several retail outlets which denied many other consumers the opportunity to purchase the important product. If the product is not really a necessity, a consumer may choose to forego it and buy its cheaper substitute such as soap. This frees up the product for someone else who is willing to pay the higher price for it.

Price increases due to high demand also offer incentives for additional suppliers to produce and supply the product. This brings about competition among suppliers, and ultimately it reduces the prices of the commodities because there are no shortages.

Third, price increase reduces wastage. Due to the high prices, consumers are more careful in the manner in which they use it. For example, if the product in demand was toilet paper, the consumer would be careful how much of it they used, and for what purpose. For example, they would choose to use a cloth to wipe a surface rather than use the toilet paper. Eventually, this would contribute to the reduction of solid waste pollution.

Confiscating the generators and locking up the entrepreneur in Mississippi, both the desperate consumer and the businessman worse off. Likewise, vilifying Cleanshelf supermarket with anti-price gouging laws was counterproductive because it harms the very people these entrepreneurs are intending to serve.

If suppliers are mandated by law to sell the same goods for the same price they would get under normal circumstances, they are disincentivised to increase production and supply against all odds under extraneous circumstances and transport them to the disaster site. This results in shortages of the very essential items that are required during the disaster. Resultantly, the supplies dwindle, the shelves are emptied and eventually, the retailers close down their shops because there is nothing more left to sell. Everybody loses.

So should the supermarket be celebrated or vilified for adjusting their prices according to the sharp increase in demand? Whose argument will sway the day? The economist’s or public sentiments? You be the judge.

Finally, my unsolicited advice is to CAK: It is impossible to make a man understand something when his salary depends on him not understanding it. Likewise, the desire to control prices, especially during a disaster, is understandable because it is good optics when you are seen as doing something noble in favour of the people already in distress, but what is unseen is that only a few people who get the limited supply of the product benefit, while the majority continue to suffer.

However, price gouging laws is bad economics because it creates further shortages, reduces consumer incentive to conserve, and demotivates suppliers from supplying more, which would normalise the price and benefit more consumers.

Price ain't merely about numbers. It's a satisfying sacrifice - Toba Beta