Marketplace: Price Increase or Price-Gouging?
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Posted June 23, 2008
Author: Council for Economic Education Technology Staff
Posted: June 23, 2008
Students learn about price-gouging. Using a hypothetical post-disaster example, they will learn more about supply and demand, as well as the complexities associated with price increases in a supply-constrained market.
- Learn about market forces, supply and demand, and price-gouging.
- Debate the validity of extreme price increases by exploring and expounding upon a hypothetical post-disaster scenario.
- Examine the reasons for price increases in a supply- constrained market.
- Consider the alternatives to price increases in a supply- constrained market.
Present the students with a brief statement of the central issues addressed in the lesson: Our economic system is called capitalism, and its basic engine is called the market. A market economy is made up of buyers and sellers. Buyers try to get what they want for the lowest price possible, and sellers want to get the most money they can for the things they are selling. Together, this push-pull effect helps keep the market system in balance.
One of the mechanisms that helps maintain this balance is called supply and demand. The central principle of supply and demand is that prices are determined by the levels of supply (amount of items available) and demand (degree to which an item is desired). If more people want to buy a particular kind of product, the large demand will make the price increase. If fewer people want that kind of product, the price will decrease. Supply is quite similar. If there is a low supply of a particular product, the price will be higher than if there is a glut of similar resources on the market.
How does this interaction of supply and demand affect pricing? What happens if supplies run low of something everyone needs in order to live? Let's find out more.
Tell the students that market forces of supply and demand help to keep the capitalist system in balance. Earthquakes, floods, and other natural disasters often cause extreme shifts in the supply of and demand for certain items. When extreme events affect supply or demand for a particular item, pricing may seem outrageously inflated - something people often refer to as "price-gouging." In fact, however, when demand outstrips supply in an extreme way, the natural response of a market should be for the price to increase significantly.
To learn more, students will enter DISASTER ZONE by assuming the role of the shopkeeper, Mr. Green, and allowing the students to assume their roles as members of the crowd. In either event, encourage some form of interchange that explores the alternate means by which this scarce resource might be distributed.]
Pose these questions and discuss the students' responses:
Do you think Mr. Green's solution was the best way to distribute the water? Can you think of other ways in which the water could have been distributed? What do you think will happen to Mr. Green's sales in the long run, based on his method of distributing the water?
In this scenario, each person or family unit receives a certain amount at the pre-disaster price, regardless of need.
Problem: Among any group of free people in this situation, some would choose to resell their allotment for significantly more money than they paid, and the accusation of price-gouging could once again be leveled. And, if resale were somehow prohibited, how else would those people who have a greater need for water obtain it? Would they be forced to watch as those with a lesser need expend a portion of their allotment on frivolous activities, such as washing a car?
- Price controls:
In this scenario, the price would be held at its pre-disaster levels, post-disaster changes in the market notwithstanding.
Problem: Given that there is not enough supply to meet everyone's demand, some sort of queue, or line, would be required. How would one's position in the queue be determined? Would it be first-come, first served? This would favor: (a) the people nearest the water store [unfair because their need might not be the greatest], or (b) the people who first learned about the queue [unfair for the same reason], or (c) the people who could run the fastest [unfair because it favors the young and the swift.]
Perhaps other criteria could be used to determine one's position in the queue.
- How about a wrestling match? [This would favor the strong.]
- How about a chess competition? [This would favor those good at chess.]
- How about a beauty pageant? [This would favor the beautiful, and the determinations are subjective.]
Challenge the students to say whether any of their ideas are more “fair” than charging extra money for the water. Do any of the proposed solutions to the problem favor one group over another? On a separate piece of paper, or together with the rest of the class, make a list of all the alternatives the students can think of for distributing the water. Next to each alternative, they should write down who is favored and who does worse in each distribution scenario.
Then pose these questions:
- All things considered, which scenario do you think is the best?
[Each one of these scenarios favors one group above another, and no scenario is entirely fair. Governed by market forces, exchange of money is the primary means by which goods and services are distributed in society, and it is a means that we all have in common. Price controls do not solve the problem because there will still be a shortage, and over time this can exacerbate the problem. It is true that, in our post-disaster, supply-constrained water market scenario, the poor are not favored if money exchange is the means by which the water is distributed. However, there is no reason to believe that poor people would necessarily do better if strength, swiftness, beauty, or other such criteria were used. The fact is that in the case of each alternative some poor people would do better and some wouldn't. While no scenario seems entirely fair, it might be argued that market-governed money exchange is the least subjective. Moreover, while this is an extreme example, the price changes resultant in this scenario are in concert with the market forces that normally govern our day-to-day economic interactions.]
- How might water suppliers be enticed to make an extra effort to increase the supply of water in this earthquake-stricken town, if water is distributed via the pricing mechanism?
[It is in their interest to do so because the market will allow them temporarily to sell at a much higher price. It is also important to think about the long-term effects on the firm's decision after the disaster.Iif the firm raises the prices to extreme levels, how will that affect their sales later on?]
- How will this cause the price of water to begin to decrease? [The increase in supply will lead to the price decrease.]
In a market economy, supply and demand are the primary determinants of pricing. When the supply of a product outpaces the demand for that product, prices will naturally go down as sellers compete for consumers. When the supply of a product is not able to keep up with the demand for it, prices increase - sometimes dramatically - in response to the sellers' ability to attract consumers.
Other methods for the distribution of products can be considered, but none would be any more or less "fair" than exchange of money for goods or services - the dominant method of distribution in a market economy.
If you wish to expand upon these concepts, consider the issues raised in the following example:
These are complex questions. Extreme price increases are often labeled price-gouging and deemed unfair. But as we have seen, price increases occur because of normal market changes in supply and demand, and extreme increases can sometimes occur if the market conditions become extreme. There are times, however, when price-increases occur as a result of perceived changes in levels of supply or demand, rather than real ones. After the North ridge earthquake in Los Angeles, many people were without electricity. In order to keep their food from spoiling, some filled their freezers with ice purchased from stores in parts of the city where the power was still on. These stores were selling ice at the normal price, but there were some people who brought ice into parts of the city where the power was out and attempted to sell it for as much as $10 per bag. Market forces did not cause this price increase; there was plenty of supply in the city. The people selling the ice at an inflated price were hoping that a perceived lack of supply would be enough to get consumers to spend the extra money, and, in many cases, they were right. Price-increases that cannot be explained by changes in real levels of supply and demand are arguably far more appropriately described by the term “price-gouging.” Two lessons are to be found in this example. The first is that consumers must be savvy in order to avoid paying more than they have to, and the second is that capitalism, while it is arguably the best economic system available, functions a good deal better if sellers balance their self-interest with ethical behavior.
Assess the students' comprehension of the main concepts used in this lesson by having them work together in pairs to answer the following questions in writing (one paragraph or less per question):
If someone asked you to explain the principle of supply and demand, could you do it? Get together with the person sitting next to you, or with a group, and answer the following questions:
Answer each question in one paragraph or less.
- How do fluctuations in levels of supply and demand affect prices?
- What can happen when the demand for something is extremely high for something and the supply is extremely low?
- What are some of the ways in which scarce supplies can be distributed?
The charge of price-gouging is often leveled at the petroleum industry. Students may learn more about the complexities involved in determining whether a producer is price-gouging or simply responding to supply and demand in this “Marketplace ” segment. The text of the discussion is available, or an audio version can be heard using Real Player.
Related Lessons on demand: