The Cognitive Bias behind Anti–Price Gouging Laws
People often believe that price gouging is so obviously immoral that making it illegal is the equivalent of criminalizing theft. In their minds, sellers who drastically hike their prices after a supply or demand shock are simply cruel capitalists taking advantage of poor consumers, who are practically forced to hand over their money.
The student of economics, of course, would sooner laud this practice than condemn it. After all, price changes are an important part of the market process because they help us economize scarce resources.
In theory, then, all that must be done is to explain this process to the public. A little bit of reasoning and a few graphs are all it should take to dispel this misguided objection to market prices. Yet somehow, it rarely seems to work. Economists have been trying for decades to break the irrational opposition to price gouging, but they have had little success. As it turns out, the art of shaping public opinion is somewhat different from the art of explaining economic phenomena.
Ludwig von Mises draws attention to this distinction in the final pages of Human Action. “The flowering of human society,” he writes, “depends on two factors: the intellectual power of outstanding men to conceive sound social and economic theories, and the ability of these or other men to make these ideologies palatable to the majority.”
How, then, can public opinion be shaped? Perhaps the answer lies in psychology. After all, “irrational” is a psychological word, not an economic one. So maybe the key is not so much to explain economic principles, but to identify and debunk the various biases that give rise to the public’s antimarket beliefs.
Price gouging, I believe, provides an illustrative example of how this can be done.
Step 1: Identify a Potential Bias
Assuming that a psychological bias is underpinning the public’s objection to a certain economic principle, the logical first step is to identify what bias might be at work. To do this, it’s instructive to look closely at what exactly the public is objecting to.
In the case of price gouging, for instance, it’s worth noting that the public is not objecting to high prices per se, as we might expect, nor are they objecting to a gradual increase in prices. What really grinds their gears is a rapid change in the price. To put it technically, their fundamental complaint is that the first derivative of price over time is too high. This fact is reflected in the way anti–price gouging laws are phrased. They don’t say, “Prices should be lower.” They say, “Prices should stay close to what they used to be.”
This is somewhat different from a general objection to high prices, and it gives us a clue about what’s going on. What people are really taking issue with is not the actual price levels, but sudden deviations from the status quo. When viewed in this light, the anti–price gouging position seems to be a classic case of status quo bias.
Status quo bias is an unfounded preference for the current state of affairs and thus an irrational aversion to change. People like it when things stay the same. They get uncomfortable and even antagonistic when someone proposes a change, even if the change would actually be for the better. Thus, “This is the way things are” irrationally becomes “This is the way things ought to be.” “This is what the price has always been” becomes “This is what the price should always be.”
The idea that anti–price gouging sentiments could be rooted in status quo bias is a promising theory. If we can prove this is the case, we can show that objections to sudden price increases are indeed irrational. In short, we can debunk the anti–price gouging argument.
But how do we know status quo bias is the culprit? Sure, it’s a plausible theory, but there could be many other reasons for opposing price gouging. To make our case, we’ll need a way to demonstrate beyond a reasonable doubt that this bias is at work.
Step 2: Find a Method to Detect the Bias
One of the best ways to detect status quo bias is a method called the reversal test, which was originally introduced by Nick Bostrom and Toby Ord in their 2006 journal article “The Reversal Test: Eliminating Status Quo Bias in Applied Ethics.” Here is how they explain the test in their paper.
Reversal Test: When a proposal to change a certain parameter is thought to have bad overall consequences, consider a change to the same parameter in the opposite direction. If this is also thought to have bad overall consequences, then the onus is on those who reach these conclusions to explain why our position cannot be improved through changes to this parameter. If they are unable to do so, then we have reason to suspect that they suffer from status quo bias.
The rationale of the Reversal Test is simple: if a continuous parameter admits of a wide range of possible values, only a tiny subset of which can be local optima, then it is prima facie implausible that the actual value of that parameter should just happen to be at one of these rare local optima.
To illustrate how to use the test, Bostrom and Ord provide an example regarding the ethical dilemma of increasing human intelligence.
Many people judge that the consequences of increasing intelligence would be bad, even assuming that the method used would be medically safe. While enhancing intelligence would clearly have many potential benefits, both for individuals and for society, some feel that the outcome would be worse on balance than the status quo because increased intelligence might lead people to become bored more quickly, to become more competitive, or to be better at inventing destructive weapons….
How can we determine whether the judgments opposing cognitive enhancement result from a status quo bias? One way to proceed is by reversing our perspective and asking a somewhat counterintuitive question: “Would using some method of safely lowering intelligence have net good consequences?”
The great majority of those who judge increases to intelligence to be worse than the status quo would likely also judge decreases to be worse than the status quo. But this puts them in the rather odd position of maintaining that the net value for society provided by our current level of intelligence is at a local optimum, with small changes in either direction producing something worse. We can then ask for an explanation of why this should be thought to be so. If no sufficient reason is provided, our suspicion that the original judgment was influenced by status quo bias is corroborated.
Step 3: Apply the Method to the Argument at Hand
Armed with a method for identifying status quo bias, we can now investigate the anti–price gouging argument and see how it stands up to scrutiny.
Say a certain commodity normally trades for $10 per unit but a recent shock has sent the market rate soaring to $20 per unit. In asking for anti–price gouging laws, the public is implicitly saying that an increase in the parameter (the price) would have bad overall consequences.
The question we should ask, then, is whether the price should be set below $10 per unit. After all, if we’re going to keep the price below the market rate either way, why not push it down to $5, or even lower?
This puts the anti–price gouging proponent in a difficult position. If they say the price should be kept at $10 and not lower, they are essentially claiming that $10 just happens to be the optimal price for that commodity. Since this is extremely implausible, we have good reason to suspect they are suffering from status quo bias (irrationally preferring $10 just because it’s the historical baseline), and the onus is on them to prove that they aren’t. In other words, they have to prove that $10 exactly is the optimal price in some way, despite being well below the market rate.
Now, they could try to avoid this by saying the price cap should be lower than $10, but they would quickly run into more trouble. If they say the price cap should be $8, for instance, then we can again ask, “Why not lower?” “After all,” we continue, using their own reasoning against them, “isn’t that still ‘taking advantage’ of the buyer? Won’t people still be priced out of the market? How is it fair to allow the seller to charge that much?”
Recognizing that a price cap of zero would be nonsensical, they resign themselves to defending a middle-ground approach. “The price used to be $10!” they might retort, as if that justified their unwillingness to go any lower, but this is dangerous territory for them. Saying “It should be close to $10 because it used to be $10” is basically an admission that they have an irrational attachment to the status quo. To avoid the charge of status quo bias, they need to give a reason why $10 or anything close to it is preferable to the new market price. And just saying “Because that’s the way it used to be” is not a good reason.
We used to light our homes with kerosene lamps. That’s not a good reason to keep doing it when the world has changed.