New posting on the Pearson site regarding the fiscal cliff.

Is an Increase in Demand is “Price Gouging” ?

Keeping with the recent theme of price adjustments, or lack of them, today we are looking at one of the expected results of hurricane Sandy. An article on Yahoo! Finance’s ‘The Daily Ticker’ suggests that retailers in the Northeast United States were ‘gouging’ customers trying to purchase gas, water, food and batteries ahead of the hurricane.

The confluence of Hurricane Sandy and a strong nor’easter (as they are known) was predicted to create a massive storm over the densely populated regions of the US North East. These predictions started a week to 10 days before the storm actually hit. Hurricane force winds reek havoc with power lines and widespread power outages were expected. Hurricanes also cause storm surges, abnormally high water levels and big waves. Flooding was expected in all coastal areas.

The 50 million people that faced the potential for flooding and power outages all went to try and purchase emergency supplies at the same time. The demand for these items increased. The free market reaction to an increase in demand is an increase in price. If prices don’t rise, shortages will occur. See our previous posts on bacon and disposable diapers. This increase in price is not ‘gouging’, it is a natural reaction to an increase in demand.

In several areas there are laws against price gouging by retailers during a disaster. For example, in New Jersey prices are not permitted to rise by more than 10%. North and South Carolina both have similar laws. The general argument is that consumers should not be ‘ripped off’. But, as I teach my students, demand is defined as how much consumers are willing and able to purchase at every price. When a storm is approaching, their willingness to purchase increases – they are willing to pay more. Politicians call it gouging, economists call it equilibrium pricing.

If effective ‘price gouging’ laws are in effect, the amount that consumers are willing to purchase will be greater than what firms have available for sale and there will be a shortage. Some lucky customers will be able to purchase some batteries, or water, then stand outside the store and when the store runs out, the lucky ones will be able to sell their batteries and water at higher prices. (Sounds like ticket scalping for sporting events and concerts, doesn’t it?). The reality is that the equilibrium price must rise. The only question is who is going to benefit, the store owners, or the battery scalpers.

Lies, Damn Lies, and Medical Research

According to a recent finding published in the New England journal of Medicine and reported by Reuters, eating more chocolate increases the likelihood of winning a Nobel Prize. With the amount that I consume, I expect to be receive mine in the near future.

I’m not holding my breath however, since the study, at least as reported, has made some obvious errors in their use of statistical methods and the interpretation of the results. (Though perhaps it was intended to be facetious) The author of the study plotted the number of Nobel prizes per capita against consumption of chocolate per capita. What he found was that they appeared to form a line. A simple regression showed that the relationship was positive with a probability of error (that there was no relationship) equal to 1/10,000. Compelling evidence to be sure, until one delves into the world of statistical analysis.

The underlying theory behind the relationship between chocolate and Nobel Prizes has to do with the effects of flavonoids (whatever they are) on cognitive abilities. The more chocolate (or wine) consumed, the higher is cognitive function and this increases the probability of being awarded the Nobel Prize. There is no indication, however, that the Nobel Prize winners ever consumed chocolate. Nor did the study consider those that did consume chocolate and did not win the Nobel Prize. Forrest Gump comes to mind.

Without doing any analysis of my own, I suspect that chocolate consumption per capita is correlated with Nobel Prize winners per capita, but there is no causal relationship. There is likely a causal link between chocolate consumption and income, as chocolate is a normal good. This could be confirmed by finding, or determining the income elasticity of demand for chocolate. Alternatively, one could regress chocolate per capita against GDP per capita (PPP estimates) and the GINI index – to control for income distributions. The coefficient on income should be positive and I suspect the coefficient on the GINI Index to be negative if significant.

Next, run a regression of average education or literacy rates as a proxy for education, against income per capita; again, checking the effect of income distribution. Since education is a normal good, the coefficient on income should be positive. This shows correlation, not causation. Higher income leads to higher spending on education and higher education leads to higher income.

Finally, regress average education or literacy rates against Nobel Prize winners. More education leads to more research. More research leads to more Nobel Prizes.

The relationship observed between chocolate consumption and Nobel Prizes likely has very little, if anything to do with chocolate consumption. There is a causal relationship between income and both education and chocolate consumption. Thus, there is a correlation between chocolate consumption and education and therefore, between chocolate and Nobel Prizes.

Consider this an open invitation for any reader to undertake the proposed research. Perhaps the New England Journal of Medicine will publish it.