Shaughnessy Consulting, LLC currently enjoys a patent on software that estimates economic damages for clients involved in personal injury lawsuits. Demand for my software is

Q_D = 500 - 6.25P. Creating the software cost me about $1,850 in development and coding. I can produce a copy of the software for $6.40 per unit (constant cost).

a. How many copies of the software should I attempt to sell? At what price should I sell it? How much profit would I make?

b. My patent expires in a year, and I know other economic consultants will produce competing software. What quantity and price will result once competing software emerges? How much consumer surplus will my clients (lawyers) gain once the competitors enter? (For measuring consumer surplus, recall that area of a triangle = * base * height.)

c. How much deadweight loss is created by my patent and monopoly in this software?

After considering the situation of market power for my software and how it changed after the introduction of competitors, consider situations of natural disasters and how governments respond to shortages resulting from them.

a. Read this article and comment on why anti-gouging laws can increase social welfare (i.e,. make society better off).

Column: Memo to economists defending price gouging in a disaster: It's still wrong, morally and economically

As surely as flooding disasters like Hurricane Harvey are followed by health concerns and homelessness, they're followed by calls to legalize price gouging.

This time around, the first such calls were heard while the waters were still rising all across the Houston area. They came from conservative economists Tim Worstall of Britain's Adam Smith Institute, writing in Forbes, and Mark Perry of the American Enterprise Institute, whose piece appeared on the AEI website and at Newsweek. Both demonstrated the chief flaw of such analyses: They were based on irreproachable textbook economics, and showed no sensitivity whatsoever to how things work on the ground during a major catastrophe.

As I've observed before, the odd things about these defenses of price gouging is that they cross ideological boundaries they're often favored by conservatives and liberals alike. It's unclear why this should be so, unless liberals relish the rare chance to show that they're not opposed to the free market now and then. But the notion that the free market can somehow redress the extreme disruption of supply and demand that occurs during a disaster is exactly wrong.

When the market breaks down utterly, as in Houston, where huge swaths of the region will have little or no access for days at least to fresh water, auto fuel and electricity, almost nothing the free market can do will get supplies of these commodities to places that can't be physically reached. Instead, the market will impose a level of price discrimination that could become life-threatening for people at the wrong end of the income stream. If one conceives an important function of government as ensuring that the market doesn't unduly disadvantage some people compared to others, then times like this are precisely the moment it should step in by putting a leash on profiteering on essential goods, for instance.

The problem with the free market is that it's not really universally "free." Not all participants come to the marketplace with equivalent standing. In a crisis, those disparities are magnified.

Let's see how reality conflicts with the idealized pictures offered by Messrs. Worstall and Perry. When the municipal water supply is knocked out and people are dependent on bottled water, Worstall proposes: "We now need some method of rationing that limited and scarce supply over that increased demand. Rationing by price is always the efficient way of doing this." He argues that raising the price will encourage suppliers to flood the market (so to speak) with bottled supply. ... We want, for example, people to start trucking bottled water from Louisiana to Texas. More money to be made by doing so will encourage people to do so. And as that extra supply arrives, then prices will go down again as demand is met." It's as easy as that.

Perry's target commodities include "water, plywood, fuel, ice, generators, chainsaws, hotel rooms, etc." He writes: "As cruel as it may sound to those who are long on indignation and short on economics, market forces and market prices will address the post-disaster shortages in Texas and Louisiana more quickly and more effectively than government-determined, non-market based prices that result from price- gouging laws."

Notice Perry's swift gloss over the "cruelty" of this regime, as if that's irrelevant. Unfortunately, people at the wrong end of the cruelty continuum could end up dead.

As I've observed before, most such justifications of price gouging fail to take notice of the population that can't pay the higher (gouged) prices under any circumstances. Let's say, for instance, that the market allows a convenience store to jack up the price of a bottle of water to $7 from $1, as a resident reported to the Houston Chronicle. There's no question that the bottle would remain on the shelf, and therefore putatively available for purchase, for longer than normal, or until someone came by with such a desperate need for water that he or she would swallow the price.

Where does that leave a low-income mother with, say, three children needing to be hydrated? She might need a couple of dozen bottles, for which the price has now risen to $168 from $24. Throw in that, with the electricity out, she might not even have access to cash at an ATM. She might very well value that water at $7 a bottle, in principle. But that won't matter, because she can't afford it. This is why the public typically views price gougers as creeps. Their action substitutes one market phenomenon for another that seems much less fair: Instead of a first-come-first-served advantage, it creates a mostmoney-best-served advantage.

It's all very well to cite the textbook claim as Perry actually did in response to my earlier column that price gouging merely avoids "serious misallocation of resources." The issue for government officials tasked with managing a disrupted market is who receives the newly allocated resources. In this example, it's only those who have $168 to spend, presumably in cash.

Another factor commonly overlooked by defenders of price gouging is that natural disasters tend to be (1) short-term and (2) not amenable to rapid response by market forces. If there's no physical way to get a new supply of bottled water into some part of Houston, then allowing unrestrained price increases won't produce a larger supply. Retailers lucky enough to have a few cases in the back room when the crisis hits will reap a windfall. But who does that help, except the lucky retailers?

Another argument in favor of removing crisis-stage price controls is that they fail to accommodate the higher cost of getting a scarce commodity such as water or gasoline into the stricken market. That's a fair point, but it's also why price-gouging laws typically allow for price increases within a certain limited range, or allow higher prices where a higher transport or production cost can be documented. Perry and Worstall and other defenders of price gouging would eliminate all controls, especially in disasters.

The conventional defenses of free-market pricing tend to have a bloodlessness about them that underscores their irrelevance to real-world conditions. Last October, Harvard economics professor N. Gregory Mankiw spoke up for free-market pricing, using his quest for Broadway tickets to "Hamilton" as the exemplary case. He had paid scalpers $2,500 per seat and was "happy about it" because, you know, it was a hit show. Had ticket scalping laws been enforced, he wouldn't have been able to see it when he wished.

As I observed then, however, Mankiw's effort to generalize from his experience to every possible application of the market only proved the opposite point. "To be sure," he wrote, "most people can't easily afford paying so much for a few hours of entertainment. That is indeed lamentable." The word "lamentable" was asked to carry a lot more weight in that sentence than it should. Substitute "paying so much for drinking water," or "shelter," or "life-saving medicine," and the situation starts to look a lot worse than "lamentable," doesn't it? Anyone can survive missing out on "Hamilton." Those other things, not so much.

Certainly there are situations where price controls are too rigid or even unnecessary. But when the task involves opening access to a market isolated from the outside world by natural disaster, the free market is powerless to help; its only ability is to direct scarce, life-giving resources exclusively to those who can pay.

The only force that can address the market is government, by making the cost of crucial commodities irrelevant by getting them into the market at its own cost. We're talking about a case where nature herself has thrown the economics textbooks into the drink. It behooves academic economists like Worstall, Perry and Mankiw to keep something in mind, always: We're not talking about tickets to a show.

b. In contrast, read this blog post and comment on why price gouging may increase social welfare.

Price Signals, Price Gouging, and Philanthropy

By:

Peter Calcagno

In the wake of the (COVID-19) pandemic news outlets and politicians alike are discouraging everyone from price-gouging and hoarding. The question is why? We are told that to raise the prices during a crisis such as a natural disaster or a pandemic is cruel and unethical. However, as any good principles of economics student can tell you, price gouging laws only create price ceilings and shortages of goods. No one is directly calling for the capping of prices on goods during these times of crisis, but price gouging laws are effectively the same. Producers are afraid of raising prices for fear they may be reported as price gouging, and in many states, the burden of proof is on the producer to demonstrate they did not engage in price gouging.

The issue at hand is an old one in economics that people keep failing to learn. Prices are signals that contain information and incentives and help to ration goods. F.A. Hayek demonstrated that we do not have to know why prices are rising to understand how to behave. As consumers, we economize on goods, and producers understand that there is a greater demand for the product and should offer more to the market. What price gouging laws cannot do is change the scarcity of resources as Michael Munger explained to us years ago after Hurricane Fran. Instead, we have to find new ways to allocate scarce resources like waiting in line for first come, first served, or worse discriminatory practices. Yes, this sometimes forces us to make hard choices as to whether we should forgo the beer for toilet paper (or maybe it's the other way around).

Preventing prices from rising only creates confusion among producers and consumers. Producers do not receive the necessary signal that more products should be supplied, especially if one area of the country is affected more relative to another, such as after a natural disaster. We should allocate more resources to those areas affected, bringing their prices down and increasing prices in other places to signal the relative scarcity. While we are all suffering from this pandemic, maybe the area first affected or areas of more cases should have had more hand sanitizer or wipes supplied to them. However, without the right price signals, how will we know? People hoard (I dislike this term almost as much as price-gouging) because they have been incentivized to do so. The product is still cheap, and so they buy more than they need in anticipation of higher prices or shortages in the future. However, higher prices are more effective at encouraging people to purchase only what they may require, or can afford, than the pleadings of government officials.

We are told that business people should not be greedy during times of crisis and not engage in profiteering. What exactly does that mean? Allowing markets to create the right signals does not necessarily imply excessive profits (if we even know what the means). The price signals and profit opportunities will only lead suppliers to find ways to make the product more available and drive down prices faster. We can debate about whether individuals like the man in Tennessee who drove all over the state purchasing hand sanitizer and other products to sell at a higher price are simply responding to arbitrage opportunities. I would argue that this is also an unintended consequence of price gouging laws creating unnecessary secondary markets where people attempt to raise prices, and sometimes engage in unscrupulous behavior.

Are rising prices and profiteering the only way that businesses respond to a crisis? If you ask politicians, most journalists, and even your neighbors, they would probably say yes. Adam Smith in the Theory of Moral Sentiments wrote that people not only want to be praised but praiseworthy. High prices can motivate people to be praiseworthy. (David Henderson spoke about doing just that in his recent AMA.) Business leaders and entrepreneurs are often on the front line of providing goods and services during a crisis. A few examples include Budweiser switching their production from beer to water following Hurricane Florence to send to victims in North Carolina, South Carolina, and Virginia. Short-term rental giant Airbnb was able to use its network to provide free housing to people during Hurricane Dorian when hotels could not accommodate all the individuals needing shelter after evacuating their homes. Finally, in the current crisis, online platforms such as Zoom are providing access to their product for free so educators can teach online. Still better, entrepreneurs are adapting to the circumstances to help solve problems as in the case of the distilleries that are turning high-proof alcohol into hand sanitizer. Chad Butters brewery founder stated "The right thing to do is support this community by providing something that is in desperate need. We'll flood the valley with hand sanitizer and drive that price right down." Whether he fully understands it or not, high prices are doing exactly what they should be doing in this situation- moving resources to where they are most valuable.

What is the best thing we can do in a time of emergency or crisis? We can, of course, be kind to each other; businesses and individuals can engage in philanthropy, but more importantly, we can let markets function to provide proper price signals and allocate resources where they are most desired. If you think that price gouging is a problem or unethical then consider Matt Zwolinski's argument to the contrary. More importantly, when you are staring at the empty shelf in the store, ask yourself are the low prices, the threats of legal action, and the pleading not to hoard by state officials truly helping to solve the problem?

c. Which argument do you find more persuasive, and why? I.e., should governments continue to use anti-gouging laws to correct supposed market failures occurring after natural disasters?