The term 'Price Gouging' is included in the Economics edition of the Financial Dictionary. Get your copy on Amazon in Kindle, Paperback or Audio edition. Choose your edition here...
Price gouging involves businesses charging higher prices than those that are considered to be fair or normal. It is most often done when there are crises or natural disasters strike. This gouging could also result from temporary boosts in demand that are not matched by supply. If suppliers’ expenses rises, this is not considered to be a form of gouging when they pass it along to customers.
Because price gouging is usually considered to be unethical, it is generally treated as strictly illegal in a great number of places. Interestingly though, this gouging originates from what many economists call an efficient market outcome.
As demand goes up for a given product, this signifies that consumers will and are able to pay more to purchase an additional quantity of the good at the fair market price. Increases in a good’s demand generally lead to short term product shortages. Suppliers are tempted when they see extended lines of people forming (to purchase their product) to both raise their prices and to increase the amount of their product that is available. Suppliers who are retailers will attempt to bring in more product into their stores. Supply and demand return to balance at a higher price in many examples.
When demand increases, everyone can not have the amount that they want for the initial market price. This means that if the price does not go up, shortages will occur. It is because the supplier needs an incentive to provide a greater amount of the goods in question. As supply and demand return to balance, all people who are capable of paying the market price can obtain as much as they need.
The supply and demand balance proves to be efficient economically. The goods go to all individuals who want the product for a greater price than they cost to make. Companies can maximize their profits as well. With shortages, there is no set way that the goods become rationed. Though usually this is on a first come, first serve basis, it might be resolved through bribes to the owner of the store. Such a bribe would amount to raising the price anyway.
It is critical to realize that in times of excessive demand, everyone can not obtain their full demand for the product at the original price. Higher prices will generally increase the amount of good supplied so that those who wish most to have them can. This should not be confused with price gouging per se.
There are many critics of price gouging, including most governments. These critic argue that short term supply can not be adequately resolved by higher prices. Demand increase in cases like natural disasters do not allow for suppliers to provide more of the product. They only lead to increases in the price or shortages. This is because supplies in these cases are limited to the inventory a store has on hand.
The critics say that such short term shortages and accompanying price gauging only leads to suppliers realizing excessive profits at the consumer’s expense. Though higher prices are often illegal in such cases, these prices serve a purpose. They distribute the goods more efficiently than prices which prove to be artificially low will since they lead to shortages.
As a classic example, when there is an increased demand, higher prices will reduce hoarding by the people who arrive first at the store. This means that there should be more of the demanded good remaining for others who arrive later and are willing to pay more than the original price.