Monday, December 24, 2012

Offsetting Behaviour: In praise of price gouging, revisited

Offsetting Behaviour: In praise of price gouging, revisited

"Ely argues that we can have cases where supply is effectively fixed. Consequently, the only gains we get via gouging are in ensuring that goods are allocated to their highest valued use; we don't get increased supply. In that case, we weigh the gains from improved allocation against the losses to inframarginal consumers who have to pay more."

A natural disaster is usually a Roy situation, the goal is then to minimize costs and losses not maximize profits. This becomes predator and prey, whoever minimizes their costs has the greatest chance of coming through the disaster ok. Consumer surplus is being Ro-R prey, for example an R gazelle has consumer surplus or prey surplus when it survives getting gouged by the claws of a predator. The predator surplus is where they catch more than they expected, in nature neither predator nor prey is better than the other but both still must struggle. Picking winners in such a situation should be on the basis of justice. 

After the February 2011 earthquake, we were in a zero-supply-elasticity world for a few goods, most notably petrol. More petrol was coming, but it wasn't going to be here for a few days. All of the petrol stations on the east side of town were out of commission due to power outages; it was very hard to figure out where you'd be able to find a petrol station with power if you lived in the east. Worse, because everyone knew that petrol was scarce, everyone panicked. If you had a car with half a tank, you filled it up. If you had two cars, you made sure both tanks were full. If you had empty jerry-cans, you filled those up too. 

A natural disaster is Oy-R chaotic, prices tend to be brittle rather than elastic. Hoarding is a logical idea because it minimizes the risk of loss from running out of a fuel, there is no real desire to maximize profits.

There were no laws against price gouging. But the petrol stations knew that every single customer would hate them if they were the only station to let prices rise such that supply and demand came back into equilibrium. And so because the stations didn't gouge, we were in a terrible equilibrium where everyone's rational response to the below-clearing price was to hoard, because there was real risk that the stations would run out of fuel. And there was real risk of running out of fuel because of the hoarding. Breaking the hoarding equilibrium would have required a coordinated price hike that both allocated fuel to its highest valued uses and told everyone that there would be fuel available for them in an emergency if they really really needed it. 

Petrol stations have to either use a cooperative strategy or a competitive one, if they cooperate in helping customers they gamble those customers will cooperate in giving them more business later rather than free riding and going elsewhere later. The normal center is that petrol stations help out their customers by quenching chaos and then customers help back by letting the petrol station recover its losses. The hoarding equilibrium is Roy, people thinking of minimizing risk, emergency fuel is an insurance based V-Bi and Y-Ro strategy like emergency funds from an insurance company preventing more damage and claims later.

I really think Ely is underestimating just how much value there can be in getting to the right allocative solution, and how a good dose of gouging can break hoarding equilibria.

Gouging is chaotic and there is no allocative solution or equilibrium, just movements between booms and busts. This gouging breaks the normal center or equilibria of cooperation.

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