Balance Sheet of Gouging

March 28, 2003 • Commentary
This article was published in the Washington Times, March 28, 2003.

Gasoline prices have gone up from a national average of $1.22 a year ago to a startling $1.71 today. The industry says it’s supply and demand. Consumer activists say it’s gouging. Who’s right? Well, both are.

The supply and demand explanation is straightforward. On top of the Venezuelan labor strike and war jitters in the Middle East, the winter in the Northeast — a region that relies heavily on heating oil — has been unusually cold. Refineries have accordingly been making heating oil rather than gasoline, so gasoline supplies are relatively scarce. Scarce gasoline equals rising prices.

But what constitutes price gouging? To many, “gouging” is selling something at the highest level the market will bear regardless of production costs. By that definition, we are indeed being gouged at the pump. Gasoline prices have risen faster than the price of crude oil.

But pricing goods and services at the highest the market will bear is what everyone in a capitalist economy does every day. Moreover, it happens regardless of whether prices are rising or falling. Oil companies were trying just as hard to charge what the market would bear in December 2001 when gasoline was $1.13 a gallon as they are now. Given present scarcities, however, the market can bear a higher price today than yesterday.

Why the constant government investigations only when prices are rising? Because to many, pricing significantly above cost is immoral and politicians and the press are in the business of finding immoral dragons to slay.

What has really set the moralizers off this time is the revelation that the gouging is often both tightly targeted and coldly calculated. The industry calls it “zone pricing.” Essentially, oil companies examine small geographic areas, consider how much retail competition exists, estimate the willingness of motorists to look elsewhere for gasoline, and price accordingly. Consumer activists are aghast that oil companies would go so far to extract every penny they can out of a gallon of gas.

Price discounting, however, clearly benefits the consumers who receive the discounts. But how about those consumers who pay prices higher than the discount? Economists of all stripes who’ve studied the effect of differential pricing based on the willingness of consumers to search for lower prices have concluded that consumers overall are likely to benefit if sales are higher with price discrimination than without it. That’s because those consumers less sensitive to prices pay more of the fixed costs of doing business.

Regardless, most people view the practice of zone pricing in gasoline markets as unfairly taking advantage of consumers. Yet many of those same people — who will curse a blue streak if you put them in front of a camera and ask them about “Big Oil” — are as we speak putting their houses on the market and enthusiastically gouging the living daylights out of anyone looking for a new home. And what’s more, they’re zone pricing.

Surprisingly, however, no one ever rages against real estate price gouging. In fact, the opposite is the case. Business reporters gush about returns, and politicians pledge to do whatever it takes to keep the real estate bubble afloat.

So is price gouging OK if you’re the gouger but not the gougee? It would appear so. But in reality, price gouging — like spinach — may be unappealing at first bite but it’s good for everyone in the long run. Gougers are sending an important signal to market actors that something is scarce and that profits are available to those who produce or sell that something.

Gouging thus sets off an economic chain reaction that ultimately remedies the shortages that led to the gouging in the first place. Without such signals, we would never know how to efficiently invest our resources. Moreover, we would have no idea what to conserve. It’s no exaggeration to state that, without such price signals, our economy would look like Cuba’s.

There’s a catch, however. If the government artificially restricts supply, those price signals will fall on deaf ears. Local zoning ordinances, for instance, often prevent real estate developers from answering the call from desperate homebuyers. They also frequently prevent new service stations from popping up to challenge the local micro‐​monopoly.

Blame not the price gouger. Blame the government that won’t let the price gouger do his job.

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