Can 'gouging' be a good thing?

When ExxonMobil, the largest oil company in the world, announced last month that its quarterly profits had surged 75 percent, to $9.9 billion, there were roars of indignation in Washington. Politicians from both parties warned that oil companies would have to convince the public they were not taking advantage of energy shortages and natural disasters like Hurricane Katrina to raise gas prices and their profits.

"If there are those who abuse the free-enterprise system to advantage themselves and their businesses at the expense of all Americans," said Republican Senator Bill Frist of Tennessee, the Majority Leader, "they ought to be exposed, and they ought to be ashamed."

SUPPLY & DEMAND

Faced with sudden price hikes, at the gas pump or in the cost of a plane ticket at Christmas, consumers and politicians alike often imagine an evil practice at work: price gouging. But is it as terrible as its name sounds?

That may depend upon whether you're looking at your own wallet or at the economy as a whole. Take the aftermath of Katrina, which devastated the Gulf Coast in August. The price of lumber and other building materials shot up after the storm. Demand for these items was suddenly higher, and sellers knew that they could charge more. So they did, in what may have seemed like acts of pure greed.

Now fast forward to next spring, when the snow has melted and a good number of homeowners around the country will start to think about building a new deck or adding a room to their house. Around the same time, the reconstruction of New Orleans should be in full swing.

Both New Orleans and all those home-improvement projects will need lumber, nails, and manpower, and most can agree that New Orleans deserves priority: Its houses and schools should be rebuilt before homeowners elsewhere spiff up their yards. With renovation costs higher, some homeowners will delay their projects until prices come back down. That will make more materials available for New Orleans and help reduce prices.

The price of gasoline also spiked after Katrina. The details were different (rather than demand rising, with oil operations in the Gulf shut down, supply shrank), but the dynamic was the same as with lumber: With not enough gas to go around, it suddenly became more expensive.

When prices at the pump rise sharply, drivers may suspect that they're being taken advantage of. "People work hard for their money, and the last thing you want to do is spend an extra 50 cents a gallon you didn't have to," says Ken Colaizzi of Denver.

Some politicians think oil companies should be forced to keep gas prices from spiking, as they did recently to a record average of $3 per gallon. In practice, though, these kinds of rules can create problems. A law like New Jersey's that forbids two price increases in one day, for example, may cause a gas station to close even when lines are long, only to reopen in the morning when it can charge more. "That's just insane," says Judith A. Chevalier, a Yale economist.

BETTER ALTERNATIVES?

It's usually a better solution to tinker with people's ability to pay. If gas prices remain high, for example, government officials may do better to raise the take-home pay of poor families with tax credits than to police gas prices. Those families could then afford their drive to work, but rich and poor alike would still need to be more discerning about how much they drive. "In all these situations, there's not enough to go around," says Russell Roberts, a economist at George Mason University in Virginia. "The question is who should get it."

When Roberts was teaching in St. Louis a decade ago, he and his wife were in fact thinking about adding a deck on their house. The architect had given them an estimate, but when it came time to build, the price had doubled. The Mississippi River floods of the mid-1990s had intervened, destroying homes and increasing the demand for carpenters' time.

So the Roberts family waited until the price came back down, and the resources went where they were needed. In addition, carpenters had an incentive to work more because they were earning more, just as unfettered gas prices give oil companies a reason to stock up before storms, or search for more oil.

There are situations where freely floating prices don't work. A wealthy person with a broken arm should not be able to outbid a poor heart-attack victim for an emergency-room doctor. Replacement kidneys should not be up for auction.

But a guaranteed right to cedar decking that costs no more than $1 a foot? Or to gas prices that change only once a day? They probably do not belong on the list.

David Leonhardt is a business reporter for The New York Times. With additional reporting by Jad Mouwad, Simon Romero, and Kirk Johnson.

LESSON PLAN 2: NATIONAL

CAN GOUGING BE A GOOD THING?

BACKGROUND

This article will help students understand that the prices they see at the gas pump or grocery are not arbitrary. In a free-market economy, forces like supply and demand help drive prices up or down. There is ongoing debate, however, about how much prices ought to be allowed to fluctuate in any given situation.

CRITICAL THINKING

* Ask students to imagine the following situations:

* They and their family go to a sports arena to see a basketball game. The price of soft drinks and popcorn are three times what they would pay outside the arena.

* Is this price gouging? Or is it simply a matter of supply and demand--the free market working as it's supposed to?

* What about someone who spots a valuable lamp at a garage sale? The person cleans it up and sells it for four times the price. How do the two cases differ?

DISCUSSION QUESTIONS

* Should oil companies be required to appear before Congress to defend their pricing?

* Under what circumstances might government forbid large, sudden price increases? (A few examples: life-threatening cases, such as access to vital medicines, life-saving operations--like the heart case in the article--or evacuation from disaster areas.)

* Do you suppose an ordinary New Orleans citizen, hit by high prices from every side, would take solace in the knowledge that those prices are just part of a free economy? From your reading of this article, what would you say to such a person about the ebb and flow of the free-market economy?

FAST FACTS

** In 1971, President Richard Nixon imposed a 90-day freeze on prices and wages, hoping to slow inflation. Soon, in anticipation of higher prices Later on, many ranchers stopped shipping cattle and consumers emptied supermarket shelves before expected price increases.

** Florida's anti-gouging Law, which went into effect in July--just before Hurricanes Katrina, Rita, and Wilma--says a price is "unconscionable" if there is a "gross disparity" between that price and the average price of the same product during the 30 days prior to a state of emergency.