Question

1) After considering the situation of market power for my software and how it changed after the introduction of competitors, consider situations of natural disasters and how governments respond to shortages resulting from them.

Read this article; what is the most likely way that anti-gouging laws potentially can increase social welfare?

Select one:

a. Penalties assessed on price gougers can be redistributed to victims or the area at large that was affected by the natural disaster. In that sense, the government wants more illegal price gouging to occur so it can prosecute and raise more revenue in fines and redistribute to voters.

b. Legislators and regulators benefit by making pronouncements against price gougers, knowing the public holds such a low opinion of them (the gougers, not the politicians :) . The public sees swift action against profiteers, and legislators/regulators enhance their standing in the public eye.

c. They increase the deadweight loss for those companies who practice price gouging. The laws raise these companies' costs so that it is no longer profitable for the companies to set price according to MR=MCMR=MC.

d. They encourage businesses to refrain from price gouging since it will negatively affect their reputations and future profitability.

2. In contrast, read this blog post; according to the post, why might price gouging increase social welfare?

Select one:

a. Price gouging will reveal the motives of greedy sellers, and thus overall supply will be reduced, which benefits consumer welfare.

b. The price can increase so high that the extra profits by "gougers" far exceeds the harm to consumers who are gouged.

c. The high price can increase consumer surplus enough that it is greater than producer surplus; since there are more consumers than producers in society, the benefit to consumers should outweigh the harm to producers.

d. While the reputation effect may be true, the high price will encourage outside suppliers to come to the affected area and will mitigate the shortage.

Article:

Charging flood victims $30 for a case of water or $10 for a gallon of gas doesn’t sit right.

And a majority of states, including Texas, have laws against price gouging. The state attorney general has threatened to prosecute people who jack up their prices in the wake of the flooding caused by Harvey. He said his office has received hundreds of reports of profiteering.

But most economists think those high prices can actually benefit communities during a crisis. Sky-high prices are the market at work, the basic laws of supply and demand in action.

“Price gouging laws stand in the way of the normal workings of competitive markets,” explained Michael Salinger, an economics professor at Boston University and former director of the Bureau of Economics at the Federal Trade Commission.

To make his point, Salinger recounted a "Dennis the Menace" cartoon he remembers from his childhood.

Dennis asked his father what causes tides. “The moon”, his father answered. Dennis offered up another explanation, that the tides were caused a big whale in the ocean. When the whale swishes his tail one way, the tide goes in, and when he swishes his tail the other way, the tide goes out.

“You don’t really believe that?” asked the father. “No,” said Dennis, “but it makes a lot more sense than the moon.”

Salinger said letting the markets work, allowing price hikes during disasters is the moon answer. It isn’t intuitive, he said, but it’s right.

There are a couple of reasons economists don’t like laws against price gouging.

On the demand side, laws that keep prices artificially low can encourage overbuying. They benefit the people who get to the store first.

“If prices don’t rise,” explained Texas Tech economics professor Michael Giberson, “they just get plenty.”

If water is cheap, I might be tempted to buy as much as I can jam in my car — just in case. If, on the other hand, prices shoot up, Giberson said, “it encourages consumers to be a little more careful in using the goods.”

There’s also a supply-side argument that economists make.

“When the price of vital goods go up in an area affected by an emergency, that sends a signal by areas not affected by the emergency to bring more,” explained Matt Zwolinski, director of the University of San Diego’s Center for Ethics, Economics, and Public Policy.

Zwolinski argues that the practice of price gouging can actually be admirable from a purely moral perspective: “It allocates goods and services in a way that best meets human needs.”

But, as with so much of economics, there is disagreement.

What are economists missing when they make these arguments?

“They are misunderstanding that if you make people mad, you pay a price,” said Richard Thaler, an economist at the Booth School of Business at the University of Chicago. Thaler co-wrote a well-known paper on price gouging that looked at what people think is fair.

It begins with the following scenario: A hardware store has been selling snow shovels for $15, and the morning after a blizzard, it raises the price to $20.

Thaler and his colleagues asked people if they thought that was fair.

“And people hate it,” he said. “They all think that’s a terrible idea.”

Thaler argued that any business that wants to still be in business tomorrow shouldn’t raise prices, because when it's time to rebuild, no one is going to want to buy new flooring from the guy that sold them the generator for double the normal rate.

Businesses and economists should pay more attention to our shared social values, argued Thaler. “During a time of crisis, it’s a time for all of us to pitch in, it’s not a time for us to grab.”

We have to think beyond the laws of supply and demand, he said, beyond pure economics.

Answer 1

1) The correct answer according to the article for first question is d. The social welfare would rise due because the business would refrain from price gauging as it effects their reputation and long term profitability. Any business that wants to continue it's market share would refrain from price gauging because public opinion for the price gaugers is not right, they percieve it to be unfair.

So social welfare rises when there is no price gauging.

2) According to the article, price gauging can increase welfare as it gives the sellers from other areas to increase the supply of the product in the effected area. It gives the Market a signalling effect and thus increase the supply during emergency times like natural disasters. It thus, increases social welfare by providing the product to the effected areas.

Thus, answer d, is correct. Even though, there is reputation effect, high price encourages the outside suppliers to come to the affected area and mitigate shortage.