Senior Fellow Kevin A. Hassett

Last week, the U.S. House of Representatives approved a measure to impose stiff penalties on anyone found guilty of gasoline price gouging. In doing so, House Democrats, under the leadership of Nancy Pelosi, once again revealed their utter contempt for free markets.

The measure was a clear attempt to pacify angry, gas-guzzling voters before the holiday weekend. Yet like many things that happen in Washington these days, the law is all for show.

It certainly looks tough. The penalties are about as harsh as they get: The government would be able to issue civil fines of as much as "three times the amount of profits gained," up to $3 million, for violators. Individuals hit with criminal charges could face up to 10 years in prison.

But the fines can only be imposed in the event the president declares an "energy emergency." Given the ramifications of such a declaration, it seems a sure bet that no sentient president would ever do such a thing.

If you consider the economics of gouging, the toothlessness of the legislation is a good thing. This action might satisfy those looking for oil-company blood, but as with all other legal efforts to address gouging, it's terrible policy.

Anti-gouging moves are bad for two big reasons. First, it's essentially impossible to distinguish gouging from normal pricing behavior. Laws against gouging merely introduce legal uncertainty and the potential for abuse.

More Harm Than Good

Second, gouging--as it is commonly understood--is just the efficient working of the price system. Interfere with high prices, and you do more harm than good.

How does Congress decide whether a company is gouging?

Suppose we observe two families with children. One has perfectly behaved little angels and pays its babysitter $5 an hour. The other has demonic delinquents, and pays its sitter $20 an hour.

Is the babysitter gouging the second family? Probably not. The difference in price just reflects the unpleasantness of the children.

Similarly, real estate is often more costly in city centers than in the suburbs. If a gasoline station in a fancy downtown neighborhood charges higher prices than a station in an outlying neighborhood, is that gouging, or just a rational response to higher costs?

I couldn't tell and you couldn't either, but Congress foolishly wants someone to make the call in any case.

The Federal Price Gouging Prevention Act defines gouging as selling wholesale or retail gasoline at an "unconscionably excessive" price, "taking unfair advantage" of an energy emergency as declared by the president.

What Is "Excessive"?

To determine if someone has charged an unreasonably high price, the Federal Trade Commission will consider the price the person (and a comparable competitor in the same area) charged 30 days prior to the emergency proclamation and whether the quantity sold during the emergency increased.

When is a price "excessive" and when is it the normal working of the free market?

As a general rule, prices will only be excessive in the presence of real monopoly power. If somebody bought up the entire U.S. supply of water, and then charged $100 a drop, then that would be gouging.

Short of that, high prices are a simple response to market conditions. If demand is high and supply tight, prices rise. Firms take "fair advantage" of market conditions to make money.

Two Outcomes: Both Bad

That is clearly what is going on in gasoline markets. Countless firms compete against each other. If one firm tried to gouge, then the others would hold their prices low and steal the gouger's customers. No firm has the monopoly power necessary to truly gouge.

So there are really only two possible outcomes from this law. If economics prevails, no firm will ever be found guilty of gouging. If economics doesn't prevail, then Kafka will rise from his grave and send gas-station owners to jail for 10-year terms depending on some bureaucrat's idea of what is fair and unfair.

The potential for harm and abuse is real. I'm a season-ticket holder for the last-place Washington Nationals baseball team. Is it "unconscionably excessive" to charge $50 a ticket for my seats? Is it taking "unfair advantage" of baseball fans to charge so much money for a team whose cleanup hitter couldn't make the roster of the Red Sox? Perhaps!

The fact is, in almost all cases, gouging is good. If a hurricane destroys the electrical systems in a city, then electricians will be in very high demand. If they charge triple their normal fee, then electricians from around the country will see the high prices, and move to the hurricane-ravaged city. Areas that stand to gain the most from returning to normal will bid the highest for electricians' services, and will be the first to return to normal.

Random Luck

If Congress steps in and stops the gouging and forces electricians to charge what they always did, then no electricians would migrate to the stricken city, and a long queue would form for low-priced service. Random luck will determine who gets their electricity up and running first, and the rebuilding period will be much longer than it need be.

High prices are a pain, but they serve a useful function. Congress should give up the gasoline witch hunt.

Kevin A. Hassett is a senior fellow and director of economic policy studies at AEI.