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Can a Business Overcharge Its Customers?

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How many times have we heard someone say that he was overcharged for something? The answer to the question of whether a business can overcharge its customers seems, on the surface, to be quite obvious. Yet, it is a question that has more than one answer.

At the end of last year, Whole Foods Market, a supermarket chain specializing in organic food, agreed to pay half a million dollars to New York City to settle allegations that it had overcharged its customers for prepackaged foods.

Also at the end of last year, Martin Shkreli, a former hedge-fund manager who went on to head three pharmaceutical companies, was arrested by the FBI after being indicted on charges of securities fraud and conspiracy. What is relevant here about the infamous Mr. Shkreli is that he was not arrested for what he did a few months prior, which some people would have liked to have seen him arrested for: buying the rights to a life-saving prescription drug and then overcharging for it.

Although both of those instances involve businesses that “overcharged” their customers, there is an important distinction between the two cases that should be maintained. Only in one case can a business legitimately be said to have overcharged its customers.

Fraudulent overcharging

Back in June of last year, the New York Department of Consumer Affairs (DCA) accused Whole Foods Market of overcharging New York City customers for some prepackaged foods by overstating the weight of the products being sold. According to the DCA, “Tests of 80 different prepackaged products bought in the company’s nine New York stores showed that all were labeled with erroneous weights.” Products mislabeled included vegetable platters, chicken tenders, and coconut shrimp.

The DCA accusation led the Whole Foods Market co-CEOs to apologize in an online video and pledge that the company would take steps to prevent overcharging its customers in the future, including increasing worker training. The company also vowed to give away any products that customers discovered were mispriced. Naturally, the bad publicity resulted in a drop in sales. And to make matters worse, the DCA fined Whole Foods Market $1.5 million for all the violations it found. A lawyer for the company said it would fight the fines sought by the DCA because they were “excessive.” It should be noted that the money collected would not be refunded to consumers but instead go into the city’s budget.

A Whole Foods Market spokesman said that its $500,000 settlement with the DCA late last year was reached “in order to put this issue behind us so that we can continue to focus our attention on providing our New York City customers with the highest level of quality and service.” The settlement was “in the best interest of the people of the City of New York and our stakeholders.” The settlement also requires Whole Foods Market to provide extra training of its New York City employees who weigh and label products and conduct quarterly in-store audits to ensure that products are indeed accurately weighed and labeled. “Whether it’s a bodega in the Bronx or a national grocery store in Manhattan, we believe every business needs to treat its customers fairly and, with this agreement, we hope Whole Foods Market will deliver on its promise to its customers to correct their mistakes,” said DCA Commissioner Julie Menin.

That Whole Foods Market overcharged its customers has more to do with fraud than it has to do with price. If a package is supposed to contain x number of pieces of a product, said to contain x number of ounces of a product, or if a product is alleged to weigh x number of pounds and it doesn’t, then it is labeled fraudulently. That could lead the purchaser of a product to be overcharged (if a package contains less product than it is supposed to) or undercharged (if a package contains more product than it is supposed to). That is true if a product is sold by number, volume, or weight, but is not the case if a product is sold by the unit. For example, roast beef, ham, and cheese might be sold at the deli counter for different amounts per pound, but also sold together for a fixed price on a platter. Charging consumers for a pound of meat or cheese while giving them less than a pound of meat or cheese is a genuine overcharge. However, no one could be overcharged for voluntarily purchasing a platter of meat and cheese sold by the unit no matter what the price was.

There are other ways that a business can fraudulently overcharge its customers. If an item rings up at a higher price than is marked on the package or that the store signage indicates, or if it simply rings up at a higher price than it is supposed to, that is a genuine overcharge. If the premium variety of a good has a higher price than the regular variety, but the package actually contains just the regular variety, then the customer is being overcharged when he pays the extra amount for the higher quality item but doesn’t actually get what the package says he is getting. The same principle applies to a service. If a carpet cleaning service is supposed to clean the carpets throughout a house but omits to clean one room while still charging the customer for cleaning the whole house, then a fraudulent overcharge has taken place.

But some things that are considered to be overcharges are not overcharges at all.

False overcharging

Former hedge-fund manager Martin Shkreli founded the biotechnology company Retrophin Inc. in 2011. The company’s board replaced him in 2014 and filed a $65 million lawsuit against him in 2015 over his use of company funds and “stock-trading irregularities and other violations of securities rules.” Shkreli founded Turing Pharmaceuticals in February of 2015 with three drugs in development acquired from Retrophin. On August 10, Turing acquired the exclusive U.S. rights to Daraprim, the trade name of the drug pyrimethamine, from Impax Laboratories for $55 million. Pyrimethamine is used both as an anti-malarial drug and as a treatment for the parasitic disease toxoplasmosis. According to the Centers for Disease Control, toxoplasmosis is considered to be a leading cause of death attributed to foodborne illness in the United States. Pyrimethamine is often used in combination with two other drugs to treat HIV-positive patients with compromised immune systems. The drug is on the nineteenth edition of the World Health Organization’s list of essential medicines. Daraprim has been available since 1953. The market for the drug is small, with only about eight thousand prescriptions filled a year. Although the patent on the drug has expired, no generic version is available in the United States, even though several companies do make and sell a generic version of Daraprim abroad.

After acquiring Daraprim from Impax, Retrophin raised the price of the drug from $13.50 per tablet to $750 per tablet—a 5,500 percent increase. According to a letter to Turing Pharmaceuticals from the Infectious Diseases Society of America (IDSA) and the HIV Medicine Association (HIVMA), “Under the current pricing structure, it is estimated that the annual cost of treatment for toxoplasmosis, for the pyrimethamine component alone, will be $336,000 for patients who weigh less than 60 kilograms and $634,500 for patients who weigh more than 60 kilograms. This cost is unjustifiable for the medically vulnerable patient population in need of this medication and unsustainable for the health care system.” In the United Kingdom, Daraprim sells for less than a dollar a pill.

The Pharmaceutical Research and Manufacturers of America and other medical specialty and patient-related organizations joined the IDSA and the HIVMA in criticizing the overcharge. Presidential candidates Hillary Clinton, Bernie Sanders, and Donald Trump weighed in as well. Clinton termed the price hike “outrageous,” and said that “price gouging like this in the specialty drug market is outrageous.” Sanders talked about the “greed” of the drug makers, and said, “They can do it. They can get away with it. They can make outrageous sums of profits and money on this and that’s what they’re doing.” He and Rep. Elijah Cummings introduced a bill in Congress aimed at curbing drug prices. Explained Sanders, “Our job in Congress is to say to these drug companies, ‘You can’t keep ripping off the American people. You can’t force folks to be in a situation where they can’t purchase the medicine they desperately need.’ That’s what we should be doing.” Trump remarked about Shkreli, “That guy is nothing. He’s zero. He’s nothing. He ought to be ashamed of himself.” At the time, Shkreli was dubbed “the most hated man in America.” After the uproar over the Daraprim price increase, Shkreli promised to reduce the price by an unspecified amount, but then later said that he would not reduce the price after all. He pledged instead to negotiate volume discounts with hospitals.

So, did Retrophin overcharge its customers? Did Shkreli overcharge for Daraprim? At what level of price increase could purchasers of Retrophin be said to be overcharged? How much would the price of Daraprim have to rise for Retrophin to be overcharging its customers? By what percentage would the price of Daraprim have to increase for Retrophin to be overcharging its customers? Would it make any difference if Retrophin had competition and there were other companies that sold forms of pyrimethamine? Would it make any difference if Retrophin raised the prices of all of its drugs at the same time or by the same amount? Would it make any difference if one of Retrophin’s competitors also began overcharging its customers? Would it make any difference if all of Retrophin’s competitors increased the prices of any or all of their drugs? Would it make any difference if Retrophin wasn’t a “lifesaving” drug? Would it make any difference if Daraprim were still protected by a patent? Would it make any difference if a generic version of Daraprim were available? Would it make any difference whether there were or weren’t a shortage of Daraprim? Would it make any difference if health-insurance companies said they would still pay for Daraprim even with the price increase? Does it matter that Daraprim was available much more cheaply in other countries? Is there anything that could justify Daraprim’s price increase?

But it’s not just Retrophin and Daraprim that are at issue here. And it’s not just the pharmaceutical industry. In the absence of fraud, can a business overcharge its customers? Any business, whether it sells products or performs services or both: gas stations, department stores, convenience stores, furniture stores, hardware stores, barber shops, auto-repair shops, pet stores, restaurants, landscapers, carpet cleaners, tanning salons, gyms, sporting-goods stores, bakeries, home-improvement warehouses, movie theaters, ice cream parlors. In the absence of fraud, is it possible for any of those places of business to overcharge its customers?

Fair and just prices

In the absence of fraud, deception, and coercion (but not necessarily in the absence of ignorance, laziness, or greed), and in the presence of a willing buyer and a willing seller, any price of a good or service is a fair and just price. A fair and just price is the market price. A fair and just price is any price voluntarily agreed to by a buyer and a seller that a buyer is willing to pay and a seller is willing to receive. It does not exist independently of a transaction between a buyer and a seller. As economists of the Austrian school maintain, value is subjective and subject to change. No good or service has intrinsic value. A fair and just price is not related to what a good or service is “worth.” Because value is subjective, voluntary exchanges always result in win-win situations for both buyers and sellers.

Prices are independent of labor, expenses, cost, and risk. They are based on the laws of supply and demand. Fair and just prices are not related to what a good costs to manufacture or a service costs to provide. That does not mean that prices are arbitrary. Prices, as George Mason University economist Don Boudreaux has explained, “(1) reflect underlying realities and, in doing so, (2) inform producers and consumers about how best to coordinate their actions with each other, and (3) give incentives to countless producers and consumers to adjust their actions to each other in coordinating ways.”

Fair and just prices are also prices that are not constrained by some arbitrary government maximum, minimum, or regulation. Laws against overcharging — price gouging or predatory pricing — violate the property rights of resource owners, they hinder the price system’s signaling ability, they contribute to the misallocation of resources, and they cause shortages. A fair and just price is both impossible and immoral for any governmental body to calculate, suggest, institute, or regulate. It is impossible because government is not omniscient; it is immoral because government has no authority to intervene in the free market. And as the economist Ludwig von Mises pointed out, “Once price control is declared a task of government, an indefinite number of price ceilings must be fixed and many of them must, with changing conditions, be altered again and again.”

The government doesn’t need to monitor the prices that pharmaceutical companies charge for their drugs in order to make sure that Americans aren’t overcharged. The government needs to get out of the business of regulating drugs, health insurance, hospitals, physicians, and medical care; eliminate Medicare and Medicaid; and let the free market work.

This article was originally published in the April 2016 edition of Future of Freedom.

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