Saturday, December 21, 2013
Whining about price gouging
One time at a dinner, I was assigned to sit next to and entertain George Akerlof. He asked me what I thought of the theory of supply and demand. I told him that it was good locally, but globally it was hard to estimate either curve, so it wasn't very helpful for large price changes. He seemed a little disappointed in my skeptical answer.
But I think I was right. Here's a picture of supply and demand curves:
How on Earth could you know the whole shape of either of these curves? If the theory is right, we're currently at or near the intersection point. So how can we know the rest of the curves?
A demand or supply curve is a hypothetical thing - it describes how customers or suppliers would react if they observed a certain price change. But to measure either curve, we need to identify shifts in the other curve; if we observe what we know is a supply curve shift, we can use that to map out some piece of the demand curve. Of course, identifying pure supply shocks or pure demand shocks is hard. But more importantly, really big shifts are really rare. So in practice it's usually impossible to know much about demand and supply curves far away from the equilibrium point. The data just isn't there. Demand could be highly responsive to huge price changes, or not very responsive at all. We just won't know until one happens.
Which brings me to price gouging. One of the few times we do see big sudden price changes is when there is a big negative supply shock - for example, a flood may cause an abrupt scarcity of fresh water, or a snowstorm may cause an abrupt scarcity of taxis. At these times, prices rise steeply, and consumers often complain of "price gouging".
Most economists and economics writers defend price gouging against the complainers. After all, it's just supply and demand. For example, the Washington Post's Neil Irwin defended the "surge pricing" that taxi service Uber implemented during a recent snowstorm.
Most econ writers and economists seem to think of anti-price-gouging complaints as being about government policy - in other words, they interpret the complaints as a populist call for the government to implement price controls during negative supply shocks. And some complainers probably really are trying to influence policy. But I think that there may be another reason for the complaints: Signalling.
Because demand curves are hard to estimate far from the equilibrium point, companies don't really know how willing people would be to pay very high prices in the event of a negative supply shock. They may make a mistake in the event of a negative supply shock, and set prices too high for a while, and thus miss a lot of profit opportunities.
But people themselves may have an idea of their own willingness to pay. It would behoove people to communicate their demand curves to the companies. So they may try to signal to companies that they would not be willing to pay very high prices, by complaining. This is probably "cheap talk", rather than a costly signal (because companies wouldn't tend to respond to only one person's complaints). Cheap talk can allow buyers and sellers to coordinate their actions better. A flood of complaints about surge pricing may help companies know not to set their surge prices too high.
In which case, complaining about the complainers would constitute interfering in the healthy working of the economy.
But anyway, I don't feel like thinking about this much more deeply at the moment, so if any of you game theorists out there want to take a crack at making a cheap-talk model of anti-price-gouging complaining, go ahead. Actually, it probably already exists.