Price Gouging and the Monopoly Option

Abstract

We investigate a dynamic oligopoly model with two phases: a normal phase where an essential input is available, and a disruption phase where firms must rely on inventories.  Disruptions create an overcutting pricing incentive arising from the option to forgo sales and monopolize the market once rivals stock out. This monopoly option causes the price to jump to a non-competitive level at the advent of the disruption and to remain above it throughout.  Price caps raise welfare, but reduce inventory investment. Government reserves implement maximal welfare, as do reserve mandates when financially feasible.

Keywords: price gouging, overcutting, price caps, strategic reserves, supply disruption, reserve requirements

JEL Classification: C73, D18, D25, L12, L13