What is Price Gouging Economics? Are Price Hikes ‘OKAY’ During a Crisis? 📊
What is price gouging economics in the market retail world today? Did the coronavirus pandemic cause it? Many experts are arguing that a price increase strategy is justifiable during the crisis. Every day consumers and shoppers, however, feel price rises are unfair and exploitative and completely unjustified.
The debate on pricing gouging economics continues unanswered and unabated.
What is clear, however, is that the uncertainty and severity of the pandemic have caused consumers and businesses to go into survival mode. More often than not, their fear translates to panic buying, causing a shortage of essential everyday items and price to increase further.
A good example of this is a medical supply company charging too much for personal protective equipment and facemasks. The company’s prices for face masks have soared since the COVID-19 pandemic unleashed panic buying in Australia. A direct comparison shows a box of 20 masks sold for up to $80 by other medical distribution businesses but was sold for $531.08 by the medical supply company in question.
Likewise, consumers have changed their shopping habits, too: visiting smaller shops, planning shopping trips for off-peak hours, replacing the usual staples, buying as a group, or – in some cases – paying higher prices. Many shoppers are wary of the price tag on products believing that their interests are not being considered during the crisis and sometimes even exploited.
In this article, you will learn how price hike economics impacts society as a whole and how to justify a price increase in the midst of a crisis without penalising the customer, consumer or shopper.
Are companies justified in raising their prices?
To understand whether businesses are justified to increase prices during a crisis, it is important to understand the key difference between price increases and price gouging. They are not the same.
So what is price gouging economics? Most price increases (not all) occur as a result of higher fixed or variable costs resulting from supply or production shortages, increasing freight costs or operational disruptions. Other price increases occur because the business is underselling themselves on a product and wants to reposition prices based on the value perceived and delivered to their customers. There is no harm here as long as the products are as valuable as the price tag indicates; the prices are in an acceptable bandwidth; and of course, customers see it this way too and repeat purchase.
Price gouging, on the other hand, is nearly always a blatant attempt to make a sudden and substantial profit from a crisis, usually at the expense of the customer.
Though price gouging isn’t a technical economics term with a precise definition. It’s about exorbitant price increases of essential goods that follow as a result of a crisis.
Signs of supply shortages
Now, if we look back at the first signs of supply shortages in the early days of the pandemic, supply constraints occurred as a result of mainly panic buying (or unpredictable spikes in consumer demand), especially for non-perishables like tinned beans.
When an unexpected demand spike like this occurs due to consumers hoarding before a natural disaster or pandemic, it is common to find that supply chains struggle to adjust to replenish supplies fast enough.
The inefficiency and time delays created by supply issues explains in part price hike economics. In effect, when supply chains cannot readily adjust to replenish supplies, businesses are forced to increase prices quickly to encourage manufacturers to make more of these goods. Manufacturers read higher prices on the customer and consumer side as higher demand or a valuable product. They then produce more of it because see this as an area of profitability.
What’s the connection between price gouging economics and a price hike?
In many cases, supply shortages or delays are often temporary. This is to let manufacturers and distributors alike catch up and meet consumer demands. Effects on a food price hike, for example, can vary, but some commodities (like sugar) have been dropping in price during the crisis while others (like rice) have been increasing, due to more people cooking indoors.
National policy changes on export and import procedures have also created issues with supply and artificial imbalances in demand. Overall, global changes in food prices haven’t been passed onto consumers immediately, unless of course retailers use economic conditions as a reason for a price hike.
Generally, what happens is the manufacturer and distributors absorb the initial costs. They then try to pass a percentage of the costs to retailers. However, major retailers especially supermarket don’t accept price rises easily. They are notorious price negotiators; and as we know from the press, major retailers put their suppliers under increasing price pressure, sometimes to the point of commoditising entire categories and brands.
But sometimes, retail delays and customer hoarding creates some good news, too. Short supply, in turn, gives manufacturers and retailers a premise upon which to reposition their prices to a point that consumers are paying prices they would have otherwise rejected prior to a crisis but should have been paying, thus setting a new price standard/realisation in the market or industry.
It applies also to grocery deliveries. For example, paying drivers more, charging customers more, and getting the supply up to a level where it’s sufficient to meet the increased demand.
Price gouging, on the other hand, is a different story. What is price gouging economics? Well, the term “price gouging” only entered the newspapers relatively recently and keeps appearing a lot during this crisis.
Price gouging is when people suspect businesses of increasing the prices of goods, services, or commodities to a level much higher than what is considered reasonable or fair. It is a blatant attempt to profiteer out of misfortune and miscommunication. It is a way to capitalise on the supply shortages that had occurred.
Usually, price gouging occurs after a demand or supply shock or shortage rather than before it. This is because it is easier for businesses to relate their massive price hike to the sudden change in consumer behaviour or supply shortage.
However, even though the rationale is appropriate and well-timed, price gouging economics states that when prices are obtained by practices inconsistent with a competitive free market or to windfall profits, this is price gouging. It can be considered exploitative and unethical.
One way major supermarkets have tried to get around the difficult price rise/gouging debate is to cap prices for day-to-day essentials over the crisis. Capping prices and restricting the number of items sold are standard practices. They were adopted by both Coles and Woolies during the crisis to prevent the hoarding of the goods. In one way, price caps have helped supermarkets promote public health and their own brands. But, the underlying reason they enforce it was because they want to regulate spending; smooth out supply without increasing prices and creating further price perception issues.
Discussion: How to reduce consumer anger to pricing increases?
A good way to reduce consumer anger to price increases during a crisis is to explain the reasons for them. Inevitably, wholesale prices will rise substantially. Many retailers will have to pass on some of those higher prices to consumers. This is normal practice that many people understand.
Another way to ease the perceived pain of price increases is to find alternative price increase strategies and limit quantities per customer rather than raise prices. But in any case, inform the customers of the reasons for pricing changes, rather than letting them assume the worst.
Yet, all the transparency in the world may not be enough for consumers worried about their finances. People are instinctively appalled by anything they perceive as price gouging, and psychology suggests that this is a strong feeling.
Economists and others also agree with consumers on this matter of inequality. They often argue that price gouging comes with significant risks to health and well being. Is it right, for instance, to increase the prices of essential goods when people are losing their job, having less money to spend on low-cost goods that they need to keep them physically healthy?
Some business owners argue that yes it is justified. They contend that they need to increase prices to stay in business. Keep their staff in jobs and serve the community. If small businesses are doing their best to serve communities despite potential health risks, why shouldn’t they earn a bit more pay? Knowing how to increase prices without losing customers is always a tricky balancing act whether you are a big or small business.
To avoid accusations of price gouging, take a more scientific approach to increase prices in times of uncertainty. Don’t take a crude percentage increase across all essential goods to protect your margins. Think about the impact this may have on customer price perception. Work out pricing strategies to increase sales that both cover your costs; maximise margins; and make sense to consumers.
Price gouging is too strong a word when businesses are struggling to stay afloat. Their supplies run out and can’t replenish due to the lockdown. Putting a price cap on items that are in short supply can ensure it can reach other consumers.
If disasters followed a free-for-all, with very high prices for essentials; then the inequality among the masses becomes much higher. Those who can’t afford high prices face extreme deprivation, even death. While those with sufficient wealth face no more than an inconvenience.
It can be challenging to identify a reasonable price increase that reflects businesses’ higher risks and costs; as well as to pinpoint where in the supply chain the cost increases are hitting hardest. It’s true especially during the proliferation of loosely regulated, border-spanning online sales.
Higher prices have the vital function of signalling to manufacturers that it’s worthwhile to create more supply. Otherwise, it may not be worth disrupting their businesses and taking risks during a health emergency.
But, unless governments are willing to provide substantial support, price caps do not inject enough cash into the economy. And, neither can they keep businesses afloat. Many economists, for example, believe that price caps aren’t effective, and could even be counterproductive in emergencies. They might encourage fighting and overcrowding in stores as people compete for scarce-yet-affordable goods.
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