The Harmful Effects of Price Gouging Laws:

Proposing Alternative, Remedial Policies

Nicholas Shea

English 138: Rhetoric and Civic Life

April 15, 2018

1
Abstract

The following writing seeks to analyze common, problematic policies that target the practice
known as “price gouging” in the wake of natural disasters, and propose viable reformations to be
implemented. Current policies misunderstand economic forces at play within post disaster
markets, and often result only in worsening disaster recovery. This paper will explain the flaws
of gouging laws and price ceilings, and propose alternative policies that would better aid overall
recovery. The solutions proposed are meant to provide a basic framework for an overall national
policy on disaster relief that is responsive to price signals and functions efficiently with the
market. Implementing these alternative policies would result in an improved situation for those
in the United States affected by natural disasters each year.

2
 Introduction

In the wake of natural disasters, such as the hurricanes that annually batter the US Gulf
Coast, prices of essential goods, such as water and gasoline, tend to rise to levels much higher
1
than their pre-disaster levels. This rise in price is often viewed very negatively, as it is perceived
that firms are taking advantage of their customers’ plight. Price increases have become so
notorious that they have been assigned the name “price gouging” which associates feelings of
anger and distrust with the phenomenon. This perception fails to fully understand the nature of
the market situation that occurs after disasters. Shortsighted policies, born from such logic,
commonly target this perceived ill and disrupt the market process, decreasing overall well-being.
Despite widespread condemnation, this rise in prices is part of a natural, and ultimately
beneficial process which allows for the greatest number of people in a given disaster situation to
maintain the greatest possible level of well-being.

A Discussion of Well-Being and the Ideal Market Situation

In a competitive market, the rationality of consumers and producers drives them each to
seek to maximize their benefits, while minimizing their costs. For producers, this means selling
at the price point at which the number of goods sold maximizes revenue. For consumers, it
means using their available resources to buy the goods that offer the most utility at the lowest
possible cost. These inversely related functions naturally tend towards an equilibrium at which
the greatest number of transactions occur and at which these transactions are overall as mutually
2
beneficial for consumers and producers as possible. In this paper, “well-being” will be used to
describe the aggregate amount of benefit that is derived by consumers from transactions within
the market. The topic of price gouging largely relates to consumer well-being, although the term
could also be applied to producers. In an ideal post-disaster market, well-being would be
maximized for consumers when the greatest number of buyers receive the goods that they
demand. A lower price must not come at the expense of overall quantity purchased if
maximizing aggregate well-being is the goal.

Causes of Market Price Increases Following Natural Disasters

The underlying factors that lead to the price increases observable in post-disaster
environments are the product of simple economic concepts. When a disaster affects an area, it
often results in the destruction of, or reduction of access to, a sizeable amount of essential goods
such as water or fuel. This destruction amounts to a decrease in the total supply of said goods
within the affected market. As a result, demand for the goods greatly exceeds supply, creating a
1
Fox, Michelle. "Price Gouging during Hurricane Harvey: Up to $99 for a Case of
Water, Texas AG Says." ​CNBC​, 28 Aug. 2017, www.cnbc.com/2017/08/28/
price-gouging-during-hurricane-harvey-up-to-99-for-a-case-of-water-texas-ag-says.
html. Accessed 4 Apr. 2018.
2
"Market Equilibrium." ​Economics Online​, www.economicsonline.co.uk/
Competitive_markets/Market_equilibrium.html. Accessed 15 Apr. 2018.

3
 3
shortage within the market. Under ordinary circumstances, the market corrects to a new, higher
market-clearing price as consumers bid up the market price of goods and producers adjust output
accordingly. Fuel prices behaved in a pattern like this following Hurricane Harvey, which caused
great damage to the gulf coast in 2017. This is illustrated by the graphic below. When firms
increase their prices in response to these circumstances, it is often perceived as “price gouging”
and is condemned by the public. However, as is represented by the supply and demand graph
below, allowing the equilibrium price to rise in response to a decrease in supply increases the
number of transactions that occur and the quantity of goods supplied. In other words, though an
increase in the market price is perceived negatively, it is simply the product of the natural
function of the market, and helps to counteract a shortage. Furthermore, when the market price is
allowed to rise to the new equilibrium uninhibited, more transactions occur overall, meaning that
more essential goods end up in the hands of the consumers that need them than would if the price
4
were to remain at its original level.

5
Image Source

3
"Supply and Demand or Price Gouging: An Ongoing Debate." ​HB Business Blog​, 13
Oct. 2016, hbx.hbs.edu/blog/post/
supply-and-demand-or-price-gouging-an-ongoing-debate. Accessed 8 Apr. 2018.
4
​ "Price Gouging in the Katrina Aftermath: Free Markets at Work." ​International
​Journal of Social Economics​, vol. 35, no. 7, 2008, pp. 512-19. ​Social
​Science Premium Collection​, doi:10.1108/03068290810886911. Accessed 7 Apr.
2018.
5
​"Change in US Regular Gasoline Prices (August 28 to September 4)." ​US Energy
​Information Administration​, 6 Sept. 2017, www.eia.gov/todayinenergy/
detail.php?id=32792. Infographic.

4
 Created by Author

Price Ceiling Gouging Laws and Their Drawbacks

As was previously explained, the shortages that result from a decrease in supply prompt
firms in the area to increase their prices according to market forces. The negative public
perception of this has resulted in many state governments passing legislation designed to prevent
firms from increasing prices of their goods during a disaster. As of 2009, thirty-two states and
6
the District of Columbia have passed legislation targeting “gouging.” Many of these ordinances
come in the form of price ceilings, which impose maximum price levels that firms are legally
allowed to charge following a disaster, often set near the pre-disaster price. Though these laws
are designed to protect consumer well-being, in reality they are problematic in two significant
ways. Perhaps the most severe detriment caused by enforcing artificially low prices during a
disaster is the severely inefficient allocation of the already scarce goods in an area. The other is
that the price incentive that would ordinarily cause firms to increase their supply to the area is
removed, causing a more sluggish return to pre-disaster overall supply levels.

A major problem that is brought upon disaster areas by price ceilings is the inevitability
of severe misallocation of the already limited supply of goods. It is common sense that in times
of urgency, essential resources ought to be rationed as well as possible, so that they may be most
efficiently used for their best possible purpose. Exactly the opposite of this occurs in situations in
which the market price is kept artificially low. A significant cause of this misallocation results
from the intuitive rationality of the consumers in the market. In such a situation, the buyers’
demand and willingness to pay for a product remains high, and greatly exceeds the available
supply. Since the price remains low, the first buyers that have access to the goods will likely buy
6
​ nyder, Jeremy. “What's the Matter with Price Gouging?” ​Business Ethics Quarterly​, vol. 19,
S
no. 2, 2009, pp. 275–293. ​JSTOR​, JSTOR, www.jstor.org/stable/27673275.

5
many more of a good than they actually need. During a disaster for instance, a family may
choose to buy five cases of water at a suppressed price of $5 per case, when they really only
needed one case to get by. If the price were allowed to increase to say $25 per case, then perhaps
the family would only have chosen to purchase one case, and likely would have used the good
more carefully. When price ceilings are imposed on such markets, the already decreased supply
of a good is likely to disappear off store shelves at alarming rates. Following the 2010
earthquake in Chile, the number of products available for purchase decreased by 32% in two
months, the following year, after an earthquake hit Japan, goods decreased by 17% in only 18
7
days. This means that not only do less people have access to the goods that they need, but those
who do gain access will likely use the goods less efficiently.

The other significant downfall of price ceilings during disasters is that they prevent the
price signals that would ordinarily lead firms to bring more supply into an area from functioning
properly. In general, the higher market prices that follow a shortage would signal to firms that
more goods should be brought to the market. Since most natural disasters are predictable in
advance, firms also would ordinarily have the incentive to stock up on essential goods, in
preparation for the likely rise in price that is to come. This anticipation by businesses is
beneficial because it increases supply of essential goods to the area, shifts the supply curve to the
right, helps to reduce post disaster prices naturally by easing the shortage and increases the
number of goods that end up in the hands of those who need them. Price ceilings break down this
incentive structure and consequently worsen the effects of shortages. Concerns are often raised
that firms might anticipate the upcoming shortage and collude to jointly, and artificially raise the
price of a good beyond its appropriate market price. It should be noted that this practice is
already illegal under federal antitrust laws and does not require a price ceiling to prevent.
Furthermore, the natural competition between the numerous firms in a disaster area would
8
otherwise prevent prices from rising beyond the efficient market-clearing price.

Arbitrage Price Gouging Laws and Their Drawbacks

In addition to firms increasing prices in response to supply and demand, another

phenomenon occurs that is commonly scrutinized as “price gouging.” This other form of gouging
occurs when people buy goods from an area where the price remains low, transport them to a
disaster area and sell them for a price higher than they were originally purchased at. This idea of
9
moving across markets in order to benefit from price difference is known as arbitrage. This sort
of price gouging has often been banned at the state level, as people are angered to see what
appears to be disaster victims being taken advantage of. In reality, this type of arbitrage is very

7
Cavallo, Alberto, et al. "Prices and Supply Disruptions during Natural
Disasters." ​The Review of Income and Wealth​, vol. 60, no. 20, 29 Aug. 2014,
pp. 449-71. ​Wiley Online Library​, doi:10.1111/roiw.12141. Accessed 8 Apr.
2018.
8
​Brewer, Michael. "Planning Disaster - Price Gouging Statutes and the Shortages They Create,"
Brooklyn Law Review ​vol. 72, no. 3 (Spring 2007): p. 1101-1138.
9
Pettinger, Tejvan. "Arbitrage Pricing Theory." ​Economics Help​, 28 Nov. 2012,
www.economicshelp.org/blog/glossary/arbitrage/. Accessed 11 Apr. 2018.

6
beneficial to the overall well-being of disaster areas. Arbitrageurs bring necessary goods into a
disaster area that otherwise would not have been introduced, increasing the supply in the market.
The subsequent increase in competition in the area causes the market price of these goods to
decline naturally, while still remaining efficient and market clearing. When laws are passed
banning this practice, the goods that would have been brought to the area remain distant, and
supply remains as low as it was before the disaster. Laws banning such arbitrage succeed only in
preventing shortages from being remedied and in preventing those affected by disaster from
receiving more of the goods that they need.

Created by Author

Viable Solutions to Maximize Well-being and Streamline Recovery

The first and most direct course of action that should be taken in order to maximize
overall well-being after a disaster is to repeal the detrimental and misguided state laws that target
“price gouging.” Price ceiling laws should be revoked in order to ensure the best possible
allocation of the limited existing supply of goods, as well as restoring the incentive system that
incites firms to bring more goods into the market in preparation for and during the disaster,
increasing supply of the sparse goods in the area. Laws prohibiting the relocation of goods into a
disaster area to be sold at a profit should also be revoked. Revoking these laws would restore a
broad incentive to bring critical goods into a disaster area, directly increasing supply, helping to
lower the market price in the area while remaining efficient and distributing the maximum
possible number of goods to those who need them the most.

Though this is undoubtedly the simplest and most direct way to improve disaster relief in
this context, it will be difficult to accomplish politically. Several major challenges stand in the
way of revoking these harmful policies. The American political system generally has trouble

7
with changing the status quo, as gridlock between parties and incentives for representatives
10
discourage progress. Most severe though is the general fact that most constituents of state level
politicians generally support such harmful policies, as they perceive them to actually be
11
beneficial. This makes it very unlikely as it stands now that any state legislator will entertain
the idea of repealing these policies. A potential solution to this could come in the form of an
incentive policy being enacted by the Federal Government. The policy would be designed such
that it would incentivize state governments to repeal both forms of gouging laws, thereby giving
state policy makers justification for such a motion so as not to anger their constituents. This
incentive structure could take the form of federal grants given to the states for the purpose of
infrastructure improvement related to disaster mitigation. These grants could be used to fund
projects such as seawalls in areas prone to hurricanes or to bolster response teams such as
firefighters in areas prone to wildfires. While allowing states to improve their disaster readiness,
these incentives would also lead states to abandon harmful policies that prevent effective
recovery.

After the issue of repealing current state gouging laws is addressed, as it is the most
fundamental solution available, other measures can be taken in order to ensure the most effective
recovery for victims of natural disasters. Aside from restoring markets to optimal allocative
efficiency, the distribution of government aid ought to be optimized as well. Evidence suggests
that the current system of federal disaster relief distribution is less than efficient. Following the
devastation caused by Hurricane Katrina, the United State Government Accountability Office
found that the ineffective oversight of FEMA resulted in $30 million in wasted or fraudulent
12
payments, including $3 million for 4,000 unused beds. A possible innovation that could be
applied to the disaster relief system would involve adjusting the current distribution system to
react to pricing data rather than less efficient signals. Under this system, government aid goods
will be prioritized to areas in which the market price for those goods is highest, which indicates
areas in which shortages are most severe. Researcher Michael Brewer supports a system based
13
on pricing because of the increase in efficiency that using price data would provide. Deciding
where to distribute aid is no easy task due to the many variables that must ordinarily be
considered. Price data may prove to be the best way to streamline federal disaster relief and
ensure that federal aid gets into the hands of the most deserving people as quickly as possible.
The introduction of government aid results in an increase in supply in that market. This increase

10
Bianco, William T., and David T. Canon. ​American Politics Today​. 5th ed., New
York, W. W. Norton & Company.
11
Dorfman, Jeffery. "Price Gouging Laws Are Good Politics but Bad Economics."
​Forbes​, 23 Sept. 2016, www.forbes.com/sites/jeffreydorfman/2016/09/
23/price-gouging-laws-are-good-politics-but-bad-economics/#663061a964d3.
Accessed 11 Apr. 2018.
12
​Ineffective FEMA Oversight of Housing Maintenance Contracts in Mississippi
​Resulted in Millions of Dollars of Waste and Potential Fraud​. www.gao.gov/
new.items/d08106.pdf. Accessed 11 Apr. 2018.
13
Brewer, Michael. "Planning Disaster - Price Gouging Statutes and the Shortages They Create,"
Brooklyn Law Review ​vol. 72, no. 3 (Spring 2007): p. 1101-1138.

8
in supply increases competition with other sellers in the area, which effectively reduces the
market clearing price without causing inefficiency. This system would ensure that areas in which
prices are highest receive priority aid, reducing the highest market prices and maximizing overall
well-being.

A major criticism of the free market approach, and justification for price ceilings, is that
they are necessary in order to protect impoverished people who cannot afford to pay the newly
increased market price during a disaster. This is a very legitimate concern; however,
implementing a market spanning price ceiling is not an effective way to improve the situation for
anyone, including low income individuals. The shortages and sellouts that are exacerbated by
price ceilings have the same negative effect on impoverished people as they do on all others, if
there are no goods available to purchase, it does not matter how low the number on the price tag
reads. A simple alternative policy could be implemented that would allow low income disaster
victims to gain access to essential goods, without inducing the crippling effects caused by a price
ceiling. The concept of price discrimination in economics typically refers to the practice of
14
charging different prices for categories of customers between which willingness to pay differs.
For instance, a theater might offer a “student discount” because they anticipate that students are
often less willing and able to pay the standard ticket price than are other customers. It should be
noted that, though the word “discriminate” sounds negative, this phrase is simply used to
describe an economic concept and is not generally a negative practice. Price discrimination is
typically employed by firms who seek to maximize profits by selling to as many customers as
possible; however, price discrimination may provide a framework for an effective policy to help
impoverished disaster victims without worsening shortages.

Legislation could be passed at the state level that requires firms to “price discriminate” on
sales of goods to impoverished people. The state could annually issue a certificate to low income
citizens, certifying their eligibility to pay discounted prices during a declared state of emergency.
When a low-income customer presents this form to a firm, the state would require the firm to
charge that customer the pre disaster price. This would effectively aid lower class victims of
disaster, while still maintaining efficient market prices for the rest of the market. This way
impoverished people would have greater access to the goods that they need, since shortages
would not be worsened by price ceilings. At the same time they would be better able to afford
such goods due to their discounted prices. Being sure to avoid price ceilings when seeking to
help the impoverished is critical to maintaining effective allocation of resources and reducing the
effects of shortages.

Addressing the Idea of “Voluntary Price Freezing or Lowering”

An idea that is becoming increasingly popular among the business community is the idea
that firms should not only voluntarily maintain prices, but voluntarily ​lower ​prices during
disasters. In a ​Harvard Business Review​ article, pricing strategist consultant Rafi Mohammed

14
Discrimination." ​Economics Online​, www.economicsonline.co.uk/
"​Price
Business_economics/Price_discrimination.html. Accessed 11 Apr. 2018.

9
 15
suggests that businesses should voluntarily lower prices during a disaster situation. Mohammed
justifies this claim by suggesting that it would be in a company’s best interest to appear
charitable to their customers by reducing prices, so as to maintain good customer relations and
potentially increase future profits. Mohammed also argues against allowing prices to increase
according to market forces, citing that this approach discriminates against low income
individuals unable to pay the market price. It is quite likely that Mohammed may be correct in
saying that lowering prices in hopes of boosting reputation could be the long run profit
maximizing option for a firm. However, what is profit maximizing for a firm is not necessarily
the most beneficial option for optimal disaster relief in this case. Regardless of whether prices
are artificially suppressed by government mandate, or by firms reacting to public anger, the same
problems will arise that impede allocative efficiency. Lowering prices will only succeed in
worsening the sellouts, shortages and poor allocation of goods that would have already been
exacerbated by maintaining the pre disaster price. As was explained earlier, price controls that
are applied to all customers within a market will not help low income people, as the cheap price
tag will do little if the good remains unavailable. Furthermore, if the aforementioned system of
“mandatory price discrimination” is applied, voluntarily lowering all prices becomes entirely
meaningless with respect to assisting the poor. Though societal misunderstanding may cause it to
be the profitable option for a firm in the long run, lowering all prices voluntarily is hardly the
best way to assist a relief effort.

Conclusions

For the foreseeable future, natural disasters will remain a fact of life for many Americans
each year, and the responsibility to aid in their recovery will maintain its importance in politics.
Though policies that impose artificial prices on markets and outlaw the practice of arbitrage
remain politically popular, they are in reality misguided and only serve to impede effective
recovery. When the goal is to maximize well-being for those affected by disaster, it is crucial to
first ensure that the true market price is allowed to efficiently allocate resources within a market
affected by shortage. To ensure that this takes place, federal incentives should be introduced,
which will lead state governments to adopt policies accordingly. To ensure that low-income
victims receive the goods they need, without contributing to crippling shortages, a system of
mandatory price discrimination should be imposed upon firms by state governments. These
reformations should be implemented at the federal and state level so that areas impacted by
disasters are able to recover as efficiently as possible.

15
Mohammed, Rafi. "Why Businesses Should Lower Prices during Natural Disasters."
​Harvard Business Review​, hbr.org/2017/09/
why-businesses-should-lower-prices-during-natural-disasters.

10