What should we do about price gouging?

During the Covid-19 crisis, a number of products have been in short supply. In some cases, this has led to sellers raising their prices substantially – a practice often called ‘price gouging’ or ‘profiteering’.

Such conduct has led to considerable public concern. During his daily coronavirus briefing on 25 March, the UK Prime Minister spoke out against profiteering ‘at a critical time and a national emergency’.

The Competition and Markets Authority (CMA) has warned that traders should not exploit the crisis to take advantage of people, highlighting its willingness to intervene if prices seem to be unjustifiably high. The CMA’s recent analysis of complaints that it has received about Covid-19-related price gouging (for which price information was provided) finds an average price increase of 160%. For hand sanitisers, the median increase was just under 400%.

There have been calls for new emergency legislation to limit price gouging, with the Prime Minister stating that the government was ‘looking at the legislative framework to see what may be necessary to do to prevent profiteering.’ Such legislation already exists in a number of countries internationally, including over 30 US states. It is typically designed to be triggered by the declaration of a state of emergency.

But why do we see price increases in emergencies? As economists, should we be concerned? And what might be done about it?

Why do we see price increases in emergencies?

One of the first lessons that economics teaches is that prices tend to increase when demand exceeds supply – when people want to buy more than firms have to sell.

In normal circumstances, this is both natural and beneficial. On the demand side, higher prices reduce total demand and mean that the people who value the product most get to buy it (because they are willing to pay the highest price). On the supply side, higher prices can provide incentives for firms to produce more, or for new firms to enter the market, thus expanding supply. The higher prices therefore act to bring supply and demand back into balance.

So why are emergencies any different?

In times of emergency, such as the Covid-19 crisis, there are four main reasons why an imbalance between supply and demand might arise, leading to a rise in prices.

• Demand for some products can increase suddenly. This could be due to an increased need for particular products, such as hand sanitisers. It could be due to demand substitution away from products and services that are no longer available to alternatives, such as from cinemas to Netflix. Or it could be due to increased bulk buying if consumers expect to go shopping less frequently.Such demand increases may be exacerbated by uncertainty (consumers may take a cautious approach if they aren’t sure how much they will need or for how long). They may also be exacerbated by expected scarcity (if consumers are concerned that stocks may run out in the future). These can lead to rational ‘stocking up’ or the more emotive terms ‘stock-piling’ or ‘panic-buying’.
• Supply can decline quite suddenly or it can become less flexible in response to price changes (more ‘inelastic’). For example, this could be due to travel or work restrictions affecting the supply chain, or because of rules that bar the production or distribution of certain products and services.
• ‘Demand dislocation’ can also create imbalances. For example, with Covid-19, cafes and restaurants have been closed and people switched to eating at home. This led to shortages of flour in supermarkets, and even though there was plenty of flour, it only came in very large pack-sizes in the catering distribution chain, and could not quickly be made available to consumers through the distribution chain for household groceries.
• ‘Strategic hoarding’ can occur. This is when suppliers or third-party intermediaries deliberately hoard scarce supplies to restrict short-term supply further and thereby drive up prices.

Any of these four imbalances between supply and demand can lead to short-term price spikes. But they need not do so. Some suppliers will take a longer-term view and seek to protect their reputation with consumers by continuing to offer good value. For example, early research shows that larger and more established suppliers have been less likely to raise prices in the current crisis (Cabral and Xu, 2020).

Should we be concerned?

Where price spikes do occur, they may be unpopular and lead to political disquiet. But are there also economic reasons for concern?

In general, there are two main ways in which we think that excessive prices can cause harm:

• First, some people will buy the product but pay more than they should.
• Second, some people who would like to buy the product at the original price might now be unable or unwilling to buy it at the higher price.

If either of these occurs, then society as a whole will be worse off. In the current situation, we might expect to see both of these happening.

Consider first the demand side:

• Price spikes very often occur for essential products – those that consumers need, and for which demand tends to be relatively inelastic (unaffected by price). When we see shortages of non-essential products, economists typically think that the best way to ration them (restrict who gets to buy them) is by using price. Typically, the people who most value the product are also those willing to pay the most: under price-based rationing, they will be the purchasers.But for essential products, consumers’ willingness to pay may not necessarily be well aligned with the benefits they receive from them. People working in care homes on a minimum wage may need hand sanitisers more than office workers working from home, but they are likely to be less able to pay an extortionate price. In such a situation, price-based rationing will not be the best way to ensure that products go to the people who value them most. It may also harm the least well off.
• There may also be important externalities, where one person’s behaviour has unintended positive or negative consequences for other people. For example, providing hand sanitisers to essential workers may help to slow transmission of the virus and provide positive benefits for wider society.
• Where demand is artificially inflated by factors such as uncertainty, expected scarcity and panic-buying, consumers’ willingness to pay may become separated from the underlying value to them of the product. To the extent that higher prices are driven by such factors, this will tend to harm society. It may also have implications for inequalities between people. Products will be bought by those who are most cautious or worried, those most able to search for supplies or those most able to afford to stock up. Products may not necessarily be bought by those who value them the most.

Now consider the supply side:

• Sharp increases in price may not be necessary to encourage firms to increase the amount they supply, or to enter a market.
  • First, there may be limited flexibility to increase short-run supply in response to a short-run price rise.
  • Second, even where there is such flexibility, high current prices do not need to be excessively high to signal an immediate supply-demand imbalance. Indeed, where information on the imbalance between supply and demand is easily available, this may be sufficient to encourage firms to expand supply without any need for a large increase in prices.
• Where prices are driven up further by strategic hoarding, prices do not reflect true demand and supply. Rather, they reflect ‘market manipulation’.
• There is a risk that inflated prices may encourage illegal activity, in the form of either the supply of fraudulent products or theft of products that are in short supply.

Finally, there are wider concerns that consumer trust could be harmed – and panic levels increased – by profiteering activity. If customers retreat from engaging in the market, they may miss out on making purchases that would be beneficial for them while businesses will lose sales. Increased uncertainty and panic-buying can further divorce prices from the true value of the products.

What should be done about it?

In the context of emergencies, there may be merit in limiting price rises.

But price regulation – setting a maximum price – can also have important negative consequences (even in addition to the normal concerns that price caps inhibit the natural market process whereby higher prices act to bring supply and demand into balance).

In particular, price regulation can:

• Encourage ‘tacit collusion’ (unspoken agreements between suppliers) up to any well-specified price cap.
• Create substantial uncertainty for firms about what prices are allowed in the absence of a well-defined price cap. This might occur especially if the costs facing firms are also changing, thereby creating a legal risk that the firms might inadvertently breach the rules.
• Damage incentives to innovate and invest if the regulated prices are set too low. In the current emergency, regulation that limited price increases could mean, for example, that suppliers are less willing to incur the costs of repackaging and the logistics required to move stocks between distribution chains to reflect the shift in consumer needs.
• Lead to supplies of products that can be sold in international markets being re-channelled towards countries with higher prices.

For these reasons, although competition authorities and regulators often face calls to intervene via price regulation in markets, they rarely do so. The only exceptions are where there is prolonged harm to consumers and the regulators do not expect normal market dynamics (such as entry and expansion of firms) to solve the problem. The UK’s existing competition and consumer legislation is not well designed to address widespread price gouging in emergencies.

If designing emergency price-gouging legislation, it may be possible to ameliorate these concerns.

• To give legal certainty to firms, and also to allow speedy and low-cost enforcement, the test for price gouging would need to be relatively clear-cut. Fortunately, given the specific, and short-term, nature of emergency price gouging, this may be more straightforward than when assessing longer-term excessive pricing. It could be stated that action would only be taken for price rises above a certain percentage (say 20%), and then only if they cannot be shown to be justified on the basis of costs.
• The fact that any rules would apply only over the short term will limit the risk of reduced incentives for long-run investment and innovation. Allowing firms to put forward a cost-based justification for their price rises would also help to reduce the risk to short -term investment: it should give firms confidence to incur additional costs where this is necessary to expand supply.
• Finally, limiting the scope of the prohibition (in particular to essential products) would allow it to be targeted at the most serious areas of concern, while creating minimal legal uncertainty and distortions to incentives beyond this.

An alternative policy approach may be to introduce legislation that specifically targets market manipulation through strategic hoarding.

What next?

In practice, many of the imbalances between supply and demand arising in the current crisis have proved relatively short-lived. The CMA’s Covid-19-related complaints data show a significant reduction in the proportion of complaints in this area. There has thus been limited opportunity to enact price-gouging legislation for it to be effective and timely.

But this recent experience may suggest that it would be useful to introduce legislation that could be ‘switched on’ quickly in a future emergency. This option would seem worthy of further consideration, if only for providing deterrent value.

What else do we need to know?

To assess the rationale for legislation, it would be useful to develop rigorous evidence on the extent of the price gouging that has in fact occurred in the current emergency, its duration and which demographic groups were most affected.

The CMA is developing research work in this area.

Where can I find out more?

Luís Cabral and Lei Xu’s study of price gouging, which finds that larger and more established suppliers have been less likely to raise prices since they want to avoid risking their reputations, is summarised at VoxEU.

The Competition and Markets Authority’s response to the Covid-19 crisis is regularly updated.

On the Covid-19 blog at Discover Economics, Sarah Smith discusses panic-buying.

Who are UK experts on this issue?

The UEA Centre for Competition Policy (CCP) has academic experts in all areas of competition and consumer policy. CCP contributors to this article include: Paul Dobson, Sean Ennis, Amelia Fletcher and Bruce Lyons.

Author: Amelia Fletcher, University of East Anglia.

Picture by Halfpoint on iStock