Read Eye on Price Gouging on p. 162 and explain why it was inefficient to stop Mr. Shepperson from selling his generators.

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EYE on PRICE GOUGING Should Price Gouging Be Illegal? Price gouging is the practice of selling an essential item for a much higher price than normal, and usually occurs follow- ing a natural disaster. In Florida and Texas, where hurricanes happen all too often, price gouging is illegal. Whether price gouging should be illegal depends on the view of fairness employed and on the facts about whether the buyers or the sellers are the poorer group. The standard view of economists is that price gouging should not be illegal and that it is the expected and efficient response to a change in demand. After a hurricane, the demand for items such as generators, pumps, lamps, gasoline, and camp stoves increases and the prices of these items rise in a nat- ural response to the change in demand. The figure illustrates the market for camp stoves. The supply of stoves is the curve S, and in normal times, the demand for stoves is Do. The price is $20 per stove and the equilibrium quantity is 5 stoves per day. Following a hurricane that results in a lengthy power outage, the demand for camp stoves increases to D₁. Provided there is no price-gouging law, the equilibrium price of a stove jumps to $40 and the equilibrium quantity in- creases to 7 stoves per day. This outcome is efficient because the marginal cost of a stove (on the supply curve) equals the marginal bene- fit from a stove (on the demand curve). If a strict price-gouging law requires the price after the hurricane to be the same as the price before the hurricane, the price of a stove is stuck at $20. At this price, the quantity of stoves supplied remains at 5 per day and a deadweight loss shown by the gray tri- angle arises. The price-gouging law is inefficient, and the price rise is efficient. Whether a doubling of the price is fair depends on the idea of fairness used. On the fair-rules view, the price rise is fair. Trade is voluntary and both the buyer and the seller are better off. On the fair-result view, the price rise might be considered unfair if the buyers are poor and the sellers are rich. But if the buyers are rich and the sellers are poor, the price rise would be consid- ered fair even on the fair-result view. Price (dollars per unit) 60 50 40 30 + 20 10 0 1 Market price rise with no price-gouging law 7 After Hurricane Katrina, John Shepperson bought 19 generators, loaded them into a rented U-Haul vehi- cle, and drove the 600 miles from his home in Kentucky to a place in Mississippi that had no power. He offered his generators to eager buyers for twice the price he had paid for them. But before he could complete a sale, the Mississippi police swooped in and arrested him. They confiscated his generators and put him in jail for four days. His crime: price gouging. Was it efficient to stop Mr. Shepperson from selling his generators Was it fair either to him or his deprived customers? S Deadweight loss from a strict price-gouging law Do 10 DI 15 Quantity (units per day)