Does Price Gouging Exist?

I first encountered the concept of price gouging while teaching economics during grad school. A quick Google search yields 1.8 million hits and a Wikipedia entry. I use it to illustrate the fundamentals of supply and demand. The story goes like this: A convenience store in Ft. Meyers Florida sells bottled water for $1.00. A hurricane hits, and the store raises the price to $3.00, effectively "gouging" customers. Politicians jump at this as unfair business tactics, and it is not, it is supply and demand. Demand for bottled water increases because clean water is more scarce. Supply of bottled water decreases because the costs of distributing/selling have increased. As such, the equilibrium price has increased due to market forces and not greedy businesses. (see illustration) No customer will pay more than they value the item, so no price gouging. In fact, there are consumers that still underpay.

This does not sit well with my students for long. They cannot reconcile the seeming "unfairness" of it all. Situations abound where prices increase (or decrease) after an event. Then, it got me thinking. The gouging comes from a change in bargaining power (i.e., holdup problem). Here are a few examples: 1) you have a heart attack, you don't take time to search and evaluate different hospitals and doctors. 2) Gas prices increase just as your car's fuel light shows empty. 3) Companies offer you a 15% pay cut, or laid off. Admittedly, this partially has to do with short-run versus long-run price elasticity, but the bargaining power also has a story. 

If these events are likely to occur, then both sides should protect themselves from it. For example, health insurance sets a fee limit (because you would almost anything for treatment), farmers sell futures of crops, airlines set contracts on jet fuel prices, and unions write up labor contracts. 

One final example. During my trip to Xi'an, China, I enjoyed haggling over different souvenirs. I bought a hat for 35 Yuan (about $6). Later, I bought the same hat, with the help of local friend, for 10 Yuan (about $1.5). Was the one store price gouging because they charged a higher price? No. Because I valued the item at $15, I instead feel I ripped off the store. In fact, my bargaining position increased with new information.

Starbucks Rewards (and Punishments)

I drive up to Starbucks to redeem a reward drink. For those of you unfamiliar with this, you register a re-loadable gift card, and every time you purchase an item at Starbucks, you earn one star. After earning twelve stars you can get any drink for free. I buy twelve espressos a week, so I am pumped! There are many reasons why this is a good business strategy; customer loyalty, targeted advertising, faster transactions, etc. Then it occurred to me; why don't we have Starbucks Punishments? Many companies and economists have evaluated firing customers by either charging them higher fees (such as at banks) or removing generous return policies (such as at Best Buy). Let's examine the proposed system.

First, we need a catchy, non-threatening name. Punishment Moons (I prefer a crimson waning gibbous). Next, how does one "earn" a moon? Economically speaking, it should be those who cause Starbucks to incur extra costs, above an average reasonable amount. Here are a few examples: 1. Order more than three waters in a single visit. 2. Talk on phone while ordering 3. Using different forms of payment for the same transaction.  4. Altering a drink so much that it becomes a different drink 5. Ponder what you want for several minutes. 6. Not using the Drive Thru. Enforcement is easy to implement since it will be performed by the Baristas. Once you reach twelve moons, the barista will then charge you for any drink they want without making it for you. This is a fair system, since it transfers some of the value of the product to the customers.

What might be better, however, is transfer stars from a violator to a customer whose cost have also increased.

How to Walk through a Doorway

You have been there before. You start to walk through a doorway, and someone else is walking towards you, trying to pass through the doorway at the same time. So, we have two people, face to face in the doorway with two possible actions, Left or Right (think of it as stage right and stage left or port and starboard). We call this a simultaneous move game because each person will make the decision at the same time. (You could argue that one could wait, but in the US the best time is now) Subtleties determine which direction you choose, but the main goal is to pass through the door quickly. There are four possibilities (LL, RR, LR, and RL). If LR or RL is played, then we have successful passing (or a Nash Equilibrium). If, however, we have LL or RR, then a new game erupts. Here's why. At LL (or RR), both players are on one side of the doorway, with a perfectly wide open space, large enough for passing, on the right. The best response, given the move L of your rival, is R, and likewise for your rival. In fact, that is the only response. So, we now have RR, and no passing. The best response the new outcome is left, again no passing, and so on.

  

 This is an example of an Adaptive Dynamic Game (related to Evolutionary stable Equilibrium) where we keep playing the game and best responding, but never settling. (This concept was introduced to me by Game Theory professor, Roy Gardner) The neat thing about it is that, theoretically, the game could go on forever, but it doesn't. So we need to add something to the model. This is the crucial step of game theory, defining the game. 

Let's go back, and again we could argue that waiting is a possibility. So, there is something idiosyncratic about the players that might make them more likely to wait. You could even have a case, where they both wait. So there might be a polite type and a rude type. We can go further by adding more moves. Here are a few strategies observed in the field: 1) the "moth" where they flatten themselves against the side; 2) the "bulldozer" where there is no turning; and 3) "committed" where the individual chooses a direction and looks down. Another addition to the model is patience. Some are more in a hurry than others, so maybe after three tries, you reset the game. But the number is arbitrary to each player. You want to announce that you want to reset the game with a perfect stranger. In the US, we like to be blunt, but no one ever says "Hey, this isn't working, let's start over." Another field observation, almost always, and usually between men, someone smugly states "age before beauty" or "shall we dance?"

A similar concept is the Four-Way Stop problem, but with more complexity.

Alumni Giving and the Homeless Mafia

I find it amusing and disturbing to read the appeals and testimonials of charitable giving, in particular to Alma maters. It usually goes something like this. "You earned your degree here and benefited from it. However, you should continue to give to ensure that those benefits continue to be available." It is as if the school can longer guarantee the quality of your degree unless you cough up the cash. I disagree with this logic because it has the appearance that the school does not know how to run a business. Imagine buying a shirt from Target for $20, only to get a call from them asking for an extra $1 so that the shirt remains popular. A degree from a university carries with it a lifetime benefit, and we make a decision if that private benefit is worth the one-time cost (tuition). The school should price the product to ensure quality because, like other businesses, would like to be profitable in the future. Possibly, as schools improve in their rankings, past students paid less than they should have. However, it is probably the past students that improved the rankings.

So, from my perspective, I refuse to give on the grounds presented. If I want to have a step with my name on it, then that is different transaction. However, from the school's perspective, they do it anyway, not because the economics is correct, but because it works. Nobody likes telemarketers, but they keep calling because someone is buying. In the same way, when asking for donations, people donate. The band, Radiohead famously asked people to pay what they wanted for their album. The same goes for homeless people. I could reason with a homeless guy that I am not obligated to pay him anything, and he would nod and walk away counting out his wad of singles. Although, I have often wondered if passers-by feel guilt and fear that if they don't give to the homeless, there might be some type of curbside revolution. If this passive extortion works with the homeless, why not with university giving? On the other hand, top students would prefer a kickback from their school.