[L]ike millions of other people up and down the East Coast, we stocked up this weekend on peanut butter and crackers and powdered milk and bottled water and cans of beans and tomatoes and tuna. The prices for all those things were the same as they always are…
Even in states without price gouging laws, most stores won’t raise prices for generators or bottled water or canned food. Which raises a question: Why? Why doesn’t price go up when demand increases? Why don’t we see more price gouging?
The people Kahneman surveyed said they would punish businesses that raised prices in ways that seemed unfair. While I would have paid twice the normal price for my groceries yesterday, I would have felt like I was getting ripped off. After the storm passed, I might have started getting my groceries somewhere else.
Businesses know this. And, Kahneman argues, when basic economic theory conflicts with peoples’ perception of fairness, it’s in a firm’s long-term interest to behave in a way that people think is fair.
The reasoning of the store is an impeccable rational choice strategy: even if the store owner wants to make money in the short run, he forgoes the extra profit in the short run to make money in the long run. That is, even if he is not altruistic, he plays the same strategy as the altruist by refraining from price gouging. That leaves the consumer. In one version, suppose the consumer does not know if he is dealing with an altruistic store owner or a “rational” player. If the store price gouges, the consumers learns the store owner is not an altruist as an altruist would never price gouge. The consumer cares about the future, like the store owner. Since the store owner is rational, he may cheat the consumer sometime in the future. This could be because of end game effects when the store owner is desperate for cash or because he thinks he is has lost the consumer’s long run business so they have switched to a “bad” equilibrium of the repeated game. (This is standard repeated game reasoning in the style of Abreu-Pearce-Stacchetti or Fudenberg-Levine-Maskin or reputation reasoning in the style of Kreps-Milgrom-Roberts-Wilson.) So, the consumer rationally does not buy in the future from a store that price gouged him in the present not because of unfairness but because he will be cheated by the store owner. So the store and consumer strategies hang together as an equilibrium based on rational choice principles.
This narrative should be added to the storybook of rational choice analysis as well as behavioral economics alternatives.