The simplest model of a market involves two things: supply and demand. The price and quantity of the goods sold in the market are a function of both. When a natural disaster hits, the immediate effect can be two-fold. In such situations, it’s not unusual that the demand for certain products may increase. For example, if everyone is trying to leave an area, the demand for gas may rise.
The other effect is that supply for certain products may decrease. For example, it may be more costly to transport gas in areas affected by a natural disaster, thus reducing the supply of gas and, in turn, increasing the price.
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DOWNLOAD NOWHow Does Supply and Demand Work?
The concept of supply and demand is used to explain how price is influenced by the supply of goods and services available and the consumer demand for those products.
Broken down, supply is the amount of goods available and demand is the customers’ willingness to pay for the good or service.
In the online course Economics for Managers, Harvard Business School Professor Bharat Anand explains demand in terms of customer willingness to pay.
“Demand curves can move over time because willingness to pay moves over time—even for the same product,” Anand says.
Willingness to pay is influenced by countless factors, including:
- Income
- Geography
- Weather
- Age
- Gender
- Brand loyalty
- Service levels
- Advertising
- Competing products
- Expectations
- Legality
- Packaging
- Environmental or social impact
- Necessity
In instances when the demand for a good or service suddenly increases, it’s natural to assume the price of the product will rise. But what about the price of essential items during a time of crisis? In these cases, most customers are willing to pay any price to obtain the needed item. But does the booming demand always justify the increased rates? When costs rise to unfair levels due to a lack of supply or boost in demand, it’s often referred to as “price gouging.”
What is Price Gouging?
Price gouging occurs when companies raise prices to unfair levels. There’s no rule for what qualifies as price gouging, but it’s not an uncommon occurrence. For example, EpiPen costs and Uber price surges are both examples of price increases that have been considered unfair.
What's the Difference Between Price Gouging and Inflation?
While price gouging is often the result of a business decision, inflation is directly impacted by the market.
Inflation is a general increase in prices caused by economic factors like demand, costs, and money supply over time. For this reason, inflation can be identified as an overall increase in prices throughout an economy over time, while price gouging is localized and opportunistic.
Another notable difference is that inflation is a natural occurrence, while price gouging is known for negatively impacting consumers and communities, often during crises or when consumers have no choice but to purchase a product.
Price Gouging During Natural Disasters
Price gouging often occurs when there’s a sudden surge in demand for a given good, service, or commodity, such as in the case of natural disasters and emergencies. In times like these, the demand for non-essential items and luxuries dwindles, leading many businesses to lose the sales they normally rely on. To offset this loss, retailers might raise the prices of essential items in an effort to stay in business. On the other hand, when the demand for essential items or services suddenly increases, the supply can quickly become very limited, further increasing prices.
The phenomenon is not new or uncommon. Stories of price gouging in Florida after Hurricane Matthew made headlines in 2016 when prices for gas, hotels, water, and other essentials skyrocketed during a declared state of emergency. The same issue arose in Texas following Hurricane Harvey in 2017.
Some items that see a surge in demand during natural disasters include:
- Bottled water
- Generators
- Plywood
- Medical supplies
- Emergency supplies
As a result, consumers see a striking difference between what they need to pay and pre-emergency prices.
When demand reaches such high levels, it can be hard to tell the difference between supply and demand and price gouging. Policymakers and business professionals have historically had mixed opinions on whether businesses should raise prices during a crisis for this reason.
Related: 5 Reasons Why You Should Study Economics
The Price Gouging Debate
Price increases due to natural disasters are a classic example of price gouging, and the government will usually intervene and directly prevent companies from doing so. But there can be unintended consequences to such market interventions, which explains the ongoing debate among economists and policymakers regarding the proper response to natural disasters and price gouging.
For business owners, deciding how to adjust prices during a time of crisis is both a practical and moral question. In many cases, raising prices on high-demand items can help offset the loss of revenue from low-demand ones and keep a company in business. At the same time, business owners are morally obligated to provide customers fair access to essential items in times of need.
Should Businesses Raise Prices During a Crisis?
For managers and business owners, deciding what’s best for both their company and its customers is a complex task, especially in a crisis.
There will always be those who try to intentionally benefit from these kinds of scenarios. Many economists argue that taking advantage of a boom in demand is a reasonable aspect of a market-based economy. But professionals often find themselves walking the line between raising prices enough to stay in business and remaining fair to their customers.
With this dilemma comes questions of practicality:
- Will raising the price of product X make up for the loss in sales of product Y?
- Are there other ways to cut costs and make up the difference?
- Does the increase in demand, or lack of supply, really justify an increase in price?
On top of these are issues of morality:
- Will raising prices limit access to essential items for those in need?
- Will making these changes inadvertently risk the health and safety of members of the community?
- Are there unintended consequences that raising prices could cause?
In Economics for Managers, HBS Professor Felix Oberholzer-Gee provides the example of home improvement company Home Depot selling plywood right before a hurricane in Florida. They decided not to mark up prices, not only for moral reasons, but as a long-term business strategy.
“Home Depot has a reputation,” Oberholzer-Gee says. “This is a repeated game. If I, as a loyal Home Depot customer, experience Home Depot price gouging, I won’t go to Home Depot anymore.”
If, after considering their reputation, a business owner decides that raising prices is the best course of action, they must determine at what point the increase crosses the line of what’s justified into potential price gouging.
To further complicate the issue, many anti-price gouging state laws provide only vague guidelines for businesses, making it even more difficult to decide where the difference between supply and demand and price gouging lies.
Price Gouging Laws
Regardless of whether a business decides to raise its prices during a pandemic, natural disaster, or other crisis, the professionals making that decision need to be aware of what price gouging laws they’re subject to.
In the United States, 24 state governments and Washington, D.C. have passed legislation prohibiting price gouging during a declared state of emergency or market disruption. During the time of the coronavirus outbreak, this number has fluctuated. States without formal price gouging laws may enact emergency legislation in certain situations.
There is no universal standard as to what constitutes price gouging. In some states, price increases that are greater than a certain percentage of the price of the same or similar items before a market disruption occurred are illegal, but those percentages vary. Other states take a broader approach by prohibiting price increases of “unconscionably excessive” amounts.
The penalties for businesses charged with price gouging also vary. In North Carolina, for example, courts can impose fines of up to $5,000 for each violation, and enforce refunds for the customers affected. Under this law, manufacturers, distributors, and retailers can be held accountable.
The Debate Continues
As the United States navigates a difficult economic time and surge in reports of price gouging, the debate of whether or not this practice is a justified response to supply and demand continues.
For managers and business owners tasked with adjusting pricing strategies in response to economic, social, and legal conditions, creating a plan that’s best for both their company and its consumers requires an intimate knowledge of business, the economy, and the situation at hand.
Not only do they need to consider the moral implications of their decisions, but know the fundamentals of economics in order to understand how the market works and the intricacies of the different factors at play.
Want to read more about the price gouging debate? Here are several resources:
- The Problem with Price Gouging Laws (Harvard Business Review)
- Post-Sandy Price Gouging: Economically Sound, Ethically Dubious (Time)
- Why Economists Love Price Gouging, And Why It's So Rare (National Public Radio)
- Why Businesses Should Lower Prices During Natural Disasters (Harvard Business Review)
Are you interested in deepening your understanding of economics? Explore our online course Economics for Managers, one of three courses in the Credential of Readiness (CORe) program. Download our free Guide to Advancing Your Career with Essential Business Skills to learn how furthering your business knowledge can advance your career.
This post was updated on December 22, 2023. It was originally published on October 13, 2016.