'GOUGING' ANXIETY IS JUST OUTRAGE OVER ARITHMETIC

Bob Tippee

With regard to anxiety about gasoline price "gouging" arising from Hurricane Katrina's unprecedented disruption of US oil supply, a few observations need to be made.

The allegations flow from assumptions that prices shouldn't rise in a supply emergency, or that they shouldn't rise as much as they do, and that if they do—and especially if sellers' profits rise at the same time—the reason must be gouging.

The problem here is obsession over price to the exclusion of sales volume.

Businesses in the delivery system for oil products base decisions about pricing and everything else on profits: total revenue minus total cost. In a supply emergency, costs rise. Revenue has to rise to cover them. And revenue is a function not only of price but of price and sales volume.

By definition, a supply emergency—such as the one occasioned by the storm-related idling of production, pipelines, and refineries along the US Gulf Coast—reduces sales volume. The reduction compels every business along the delivery chain to raise price. Across the whole chain, therefore, product values rise, lifting profits of businesses able, through cost control, to capture the gain.

Prices and profits can't rise indefinitely. The expansion of profits fosters competition from price-cutters with supply. And the price-times-volume formula governs decisions about purchases as well as sales. Buyers of oil products favor the price-cutters and lower their purchases when the product of price-times-volumes-purchased claims uncomfortable shares of their budgets.

Because scoundrels inhabit the same world as ethical business people, gouging in the sense of mean opportunism can happen. It just can't last.

The reason for this, again, is the multiplication of price times volume. A seller exploiting emergency with aggressive pricing creates opportunity for adequately supplied competitors able to charge less and generate revenue with volume. Business migrates to sellers with lower prices, and the exploitation ends.

General price leaps in a supply emergency don't represent gouging. They are natural responses, essential to restoring disrupted markets to normalcy.

Outrage over suspected gouging is natural, too. But it's distress over arithmetic, which in an emergency represents a terrible waste of energy.

(Online Sept. 2, 2005; author's e-mail: bobt@ogjonline.com)

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