Reluctance To Raise Prices Is A Problem

By | November 5, 2012

It’s not enough that there be no laws against so-called “price gouging. We also have to acknowledge the reluctance of sellers to raise prices when they expect negative customer sentiment afterwards.

There were no laws against price gouging. But the petrol stations knew that every single customer would hate them if they were the only station to let prices rise such that supply and demand came back into equilibrium. And so because the stations didn’t gouge, we were in a terrible equilibrium where everyone’s rational response to the below-clearing price was to hoard, because there was real risk that the stations would run out of fuel. And there was real risk of running out of fuel because of the hoarding. Breaking the hoarding equilibrium would have required a coordinated price hike that both allocated fuel to its highest valued uses and told everyone that there would be fuel available for them in an emergency if they really really needed it. That latter part is crucial – it kills the incentive to hoard.

How to solve that particular problem? Via When the hoarding equilibrium sets in.