Price Gouging Realities
I sell steel and I have millions of dollars worth in our warehouse. The cardinal rule of selling a commodity product like steel is that you always sell based on your replacement cost. This is true of any volatile commodity product; steel, sand, bricks, lumber, or gasoline.
Let’s say I bought steel for $.30 per lb and I must add $.10 per lb to cover expenses and make a profit and I therefore sell it for $.40 per lb. After covering my expenses I have $.30 left to replace the inventory and then sell it again.
But imagine after I bought inventory for $.30 that my replacement cost goes up to $.40 cents a lb. Instead of selling for $.40 per lb I sell it for $.50 cents a lb.
But wait a minute I am making an additional $.10 on the inventory I already bought and had in stock. I am gouging! Yes I am making an additional $.10 on my OLD inventory and what do I do with the additional money? I have to spend ALL of it to replace the inventory at the new higher price. If I do not raise my price on the existing inventory I will not have the cash needed to replace it and stay in business.
If anti gouging laws keep me from raising my prices I will have less to sell without going into debt. I am liquidating my business.
Assume the reverse. I am buying for $.40 and selling for $.50, but the replacement cost declines to $.30. I would of course love to sell at $.50 and replace the material with $.30 cent material, but my competition will not let me; if I try to sell at the higher cost my inventory will just sit there. As the price drops I will make less money on my inventory because I will be selling based on the lower replacement cost. I will not have any money to cover my expenses.
I am OK with this because I made the additional markup when prices went up and I will lose it on the way down. But anti gouging legislation prohibits me from making the additional margin when prices go up, yet it offers me no help when prices go down. Over the complete price cycle I am screwed. I make less money, hire fewer people and pay less tax.
This scenario is multiplied if the legislation creates shortages. Remember the gas lines under Jimmy Carter? Let’s assume I can only get 80% of last year’s supply of steel. I still have the rent and the light bill and the payroll to pay, but I have 20% less steel to earn it. To cover my expenses I will have to make as much money on less material and I will have to raise prices to do this.
This is basic economics. This is real economics. When governments succumb to populist rhetoric to protect consumers from gougers they are ignoring these economic basics. They are robbing Peter to pay Paul.
When this happens the government can always count on Paul’s applause and approval.
But they can also count on Peter to close his shop or leave town.
Thursday, May 24, 2007