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May 1, 2020

Price Gouging or Microeconomics?

Large-scale events, such as the coronavirus, of course have broad implications, but for many of us, these changes manifest themselves in a multitude of small, practical disruptions. Our local grocery store has longer lines, items that were easy to buy now have lag times, and prices for certain goods are going way up.

Two examples are hand sanitizers and facemasks. On Amazon, the prices for both these products have spiked since the onset of the virus. Many people, naturally, feel that this is an example of price gouging—Amazon is taking advantage of the situation and deliberately raising its prices.

But I disagree. Let me explain why.

How 1P Pricing Works

Amazon 1P pricing is driven by competition in the e-commerce marketplace. Amazon always wants to offer the lowest price in relation to its rivals in the marketplace. For example, if Walmart and Target lower their prices, we would expect Amazon to do the same. Conversely, if competition increases its price, Amazon’s price typically would follow suit but may still be lower than the other two retailers. Why? Amazon is not only sensitive to other retailers but also to 3P sellers on its platform. Amazon’s 1P businesses consider 3P sellers to be competition and so they are, technically, players in the marketplace.

But what happens to pricing when other retailers, and even Amazon’s 1P businesses, run out of stock, thereby leaving 3P sellers as the only players?

How 3P Pricing Works

Amazon 3P pricing is driven by the market. It exemplifies the microeconomic model of supply and demand. Sellers iteratively set pricing based on customers willingness to buy. Those laws define what effect the relationship between the availability of a particular product and the demand for that product has on its price.

In a competitive market, the unit price for an item will vary until it settles at a point where the quantity demanded (at the current price) equals the quantity supplied (at the current price). This balance creates an economic equilibrium between price and quantity.

Supply and Demand in Action

To make this concrete, let’s get back to hand sanitizers and facemasks. On Amazon, demand for both items is off the charts. On organic search, #handsanitizer has increased over 270 times, month over month.  Search for #purell has increased over 145 times, month over month. Search for #lysol has increased 15 times, month over month. Search for #facemask has increased over sixteen times, month over month.

Microeconomics 101, the laws of supply and demand, tells us what happens when the supply is constant (for example, the market has a fixed number of facemasks for sale) and demand goes up (more people want facemasks). This graph illustrates the change.

The horizontal axis is price. The vertical axis is quantity. As demand spikes,the demand curve for, let’s say facemasks, D, increases and moves to the right to become D’. (We’re seeing linear increases in demand right now, even with rising prices, so that’s why all our curves are straight lines.) Where the demand curve intersects the supply curve is the equilibrium price (p or p’) and the equilibrium quantity (q or q’).

This graph shows  what we expect to see in the 3P marketplace. But remember, we said that Amazon 1P pricing is affected by Amazon 3P pricing. Increases in 3P pricing are also reflected in higher 1P prices.

What’s Causing the Increase?

So, are these rising prices an example of price gouging? Is Amazon doing something to control prices through manual checks of specific items? No, because it doesn’t have to. First, remember that Amazon has over a billion listings. It’s not feasible to make many, many items subject to manual controls.

Second, remember that Amazon is all about automation. It’s powered by algorithms and those algorithms are very effective. Simply by processing the data, the data that consumers themselves create, and that is modeled by the theory of supply and demand, is enough to account for the rise in prices.

Call to Action

Perhaps, if there’s a lesson to be learned, it’s that Amazon’s algorithms are powerful and impersonal. The out-of-stock shortages and price hikes we see are the result of market dynamics. This is a powerful example to brands that automation is essential to win on Amazon, as well as in any other e-commerce arena. Success in marketplaces driven by data requires a technological solution.

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