Do falling prices make us complacent?

Tim Harford writes:

…in a competitive market, wholesale price increases will be passed through to consumers promptly. But the “feather” is more ticklish, because the same argument should work in reverse, and so wholesale price falls ought to be passed on just as quickly. That means that markets are less competitive when prices are falling than when they are rising – a rather baffling suggestion.

A plausible explanation comes from Matthew Lewis, an economist at Ohio State University: falling prices make us complacent, while rises bring out the bargain hunter inside us, even when there are no bargains to be had.

As long as the price of a product is a little lower today than yesterday, we relax. We assume there’s no need to shop around. Retailers then take their sweet time cutting prices, knowing that we consumers are immensely relaxed, addled by the fact that at least prices are moving in the right direction. Paradoxically, their profits may be higher when prices are falling than when they are rising.

Comments

Certainly for gasoline retailers it tends to be the case that retailer margins on gasoline sales are higher during periods that retail prices are falling and lower during periods that retail prices are increasing. (Though contrary to Harford's characterization, wholesale price increases are not necessarily "passed through to consumers promptly." Instead, there is a brief period during which the larger margin from the prior declining price period gets absorbed.)

When prices rise we work harder to find bargains so we can become less poor. This makes sense. There is an incentive to maintain ones current standard of living. When prices decrease we work less to find even lower prices so we can become even richer. This makes less sense--There is an incentive to improve ones standard of living, yet in general we don't pursue it. Is this "rational" or evidence of the irrationality of the consumer. The producer is certainly a rational actor in this case...There has to be a behavioral economics study in there somewhere...

Alternatively "I only want other peoples' kids to pay for my old age, not my kids."

Bill once again making silly comments.

Retailers may be more reluctant to adjusts prices if the change is viewed as temporary. Retailers do not, generally, want to make consumers "price" buyers.

So I would look at elasticity. The more inelastic the demand the less likely a retailer will adjust prices. They are willing to sacrifice some marginal sales to maintain long run average profit margins. They don't chase after the very price sensitive consumers, unless that is their business model.

If the price change is viewed as permanent, or going even lower in the future, you cut prices. Look at big screen TV's. Expected future prices heavily impact prices today.

Prices quickly adjust, lower transaction costs, but expectations of future prices are more difficult to forcast.

"...a rather baffling suggestion."

Seriously? This is a mystery? Economists are so cute with their little models.

I used to be friends with the gas-station owner's kid in our neighborhood, back when owning a gas station was a middle-class occupation. Anyway, this was just before the big oil shocks in the 1970s when prices stopped fluxuating and just started going up, up, up.

Here's the trick on how gas pricing worked, at least back then. When the price went up the owner sent an employee out with a ladder to change the sign while he changed the prices on each pump. Same when the price went down.

When the price went up the owner was in a hurry because
a) he had unsold gas purchased at a lower price
b) when the tank truck brought new gas it was going to cost more anyway.
Either way he had either a direct or marginal incentive to raise the prices immediately regardless of the cost of goods in storage.

When the price went down the owner was in no hurry to lower prices because
a) he'd paid more for the unsold inventory so no way he'd lower his price prematurely
b) even after the tank truck brought in lower-priced gas the owner had to prioritize changing the sign and reducing his net proceeds over... well... just about everything else including answering the phone and serving customers.

Yes, things would have been different had there been another gas station across the street (assuming no collusion against mutually-assured destruction in a "gas war." neither of which back then was unheard of.) But that only reinforces the point: absent strong incentives only a very bad business owner passes along lower prices to his customers.

Another, shorter way of putting all the above would be a business owner raises prices of fear of losses, and lowers them out of a sense of fairness or possibly shame. Which is the stronger force?

Geez! Don't any economists know small business owners? "...a rather baffling suggestion?" Sweet mother of pearl!

figleaf

figleaf: Business owners lower prices due to competition, not just out of niceness. The more competition the less leeway they would have in setting prices.

Another, shorter way of putting all the above would be a business owner raises prices of fear of losses, and lowers them out of a sense of fairness or possibly shame. Which is the stronger force?

This, however, would be wrong. I also know plenty small business owners and managers. Another, shorter, more accurate way of putting it would be that a business owner raises prices out of fear of losses and desire for profit, keeps them the same out of fear of losses and desire for profit, and lowers them out of fear of losses and desire for profit. However, frequently managing customers' expectations and goodwill is part of obtaining profit and avoiding losses, if you're in it for the long run.

A belief that businesses lower prices "out of a sense of fairness or possibly shame" is one of the most pernicious fallacies of non-economists.

No, they don't make us complacent because markets are efficient.

Bill Bill Bill

"Holiday Price Rigidity and Cost of Price Adjustment" simply claims that prices changes, up or down , do not occur during peak demand periods. Nothing to do with what Tyler mentions above. Nor a surprising outcome. During peak demand periods labor costs are too high to try to capture the possible gains from rapidly adjusting prices in a grocery store. They are much more interested in driving floor traffic through promotions because entertaining during the holidays often drives more impulse buys and the sale of higher margin items (people tend to go upscale during holidays).

Menu cost changes for grocers are much cheaper today then they were twenty years ago. For example Dominick's no longer needs to price every item on the shelf (regulatory change) and technology has lowered the cost of tracking inventory. BTW Dominick's under different owners used to track the price elasticity of items in each store and adjusted prices based on that information.

Nothing in this article says that grocers raise prices to pass on increased prices during the holidays. Although I assure you that if meat or potatoes have a significant increase in wholesale pricing, the grocers will raise prices.

"Non-Price Rigidity and Cost of Adjustment" also claims that prices do not adjust, up or down, during holiday periods. Again this is off Tyler's point. Fewer new products are introduced during a period of peak demand. Know why? Producers know when the peak period occurs and adjust. They want everything in place in advance of the peak period. However I thing they are skipping over items that are seasonal.

"Asymmetric Wholesale Pricing: Theory and Evidence" I would suggest that the authors look at how package size is a way to adjust profits while leaving prices alone. Worse it ignores the role of the buyer for a grocery chain. A retailer may absorb the cost of small changes in wholesale prices and this can lead to asymmetric pricing as this paper claims

But while prices changes at the store level may be difficult to change, the buyer can adjust what he buys rather quickly in response to a wholesaler who's prices adjust too far from competitors. If a wholesaler becomes know for playing too many games, they can be shut out of the market, given poorer slots, etc. P&G may have more muscle then most but even they would be cautious of chasing a slight increase in profits at the expense of damaging long term relationships. It is unclear from the paper if you get asymmetrical pricing when just one wholesaler changes prices on a category of goods vs a single item. Simply Peltzman is right that asymmetric markets go away with a longer time horizon.

Managerial and Customer Costs of Price Adjustment: Direct Evidence from Industrial Markets I didn't read this, but it seems to claim that in competitive markets it is very hard to adjust prices. ie that in competitive markets prices tend toward MC = MR. Not sue how that supports you.

Well Bill I was a consultant to Dominick's once upon a time.

You seem to have missed the point. The first two papers are so so. And say nothing about the central point of this blog posting by Tyler.

The third is interesting but deeply flawed by initial assumptions. The distribution channels can impact pricing not by increasing asymmetric pricing but by reducing it overtime. Wholesalers sell to buyers. Buyers have much greater access to pricing data, and are more price sensitive, then the public. By ignoring the role of buyers, they ignored a vital gatekeeper in the process. So at the end of the day their explanation seems deeply flawed.

They didn't even mention the role of slotting allowances, coupons, advertising allowances, rebates,etc.

For example, did they look at a wholesaler raising prices slightly while increasing promotional spending?

Seasonal variations often occur in food products. Hell laundry detergent has seasonal variations that lead to sales promotion and other common non-price ways to allocate resources that are not reflected in changes in average wholesale prices..

They should have asked "What information do buyers want from wholesalers and how do they use that information?"

Now Tyler's question: is asymmetric pricing, to the degree it occurs, evidence of a market failure?

I think most sellers assume that prices will tend upwards more often then not. If prices drop the assumption is that it is temporary. The average price over a relevant time period will still tend upwards. If you price based on average costs for inventory you see fewer price changes on the retail level. In part because it is a pain to change prices and in part because over a longer time horizon it doesn't much matter most of the time. (Indeed many manufactures can buy futures contracts to insure stable ingredient costs.)

So expectations of future prices will often decide how you react to changes in current prices. It may require significant changes in prices before you change your expectations. Inflation expectations, once they took hold in the 70's, were hard to shake out of labor contracts etc.

Why are TV prices falling? Because of temporary changes in prices, or because retailers and wholesalers expect prices to continue to fall. The stronger the expectation the quicker and the more dramatic the change.

If people hear about a natural disaster on the horizon why do they rush to buy gas etc. In part out of fear that future prices will rise quickly. Demand will increase faster then supply. Suppliers didn't anticipate the increased demand. They allocate through higher prices.

With falling prices, people wait to buy. Sellers have excess inventory based on expected higher prices. They need to cut inventory by lowering prices. If the sellers expect future prices to continue to fall prices drop a great deal. If the product has a low marginal costs the price fall can be very quick. Or sellers can try to hold the line on prices in expectations of a return to more normal markets. they cut production and try to get higher margins. Or they reduce their workforce to only the most productive inputs and hopefully can maintain margins at lower prices.

House buyers expect prices to fall in the future they don't buy. House sellers expect prices to rise in the future they don't sell. Is the market have problems because of asymmetric prices or because of differing expectations?

Bill give those students a refund please.

Dan, I also note that you are agreeing with the authors you criticize on holiday pass on pricing when you state: " During peak demand periods labor costs are too high to try to capture the possible gains from rapidly adjusting prices in a grocery store." That's the point: it is the time that manufacturers, based on current data, have raised prices to retailers, knowing that the increase is less likely to be passed on at that time of the year.

These articles show how transactions costs in pricing or menu cost changes impact assymetry. I don't know why you fight it, given that you say "In part because it is a pain to change prices...." It's a pain because it is a cost.

When you don't account for transactions costs, economists can live in a frictionless theoretical universe that does not correspond to empirical reality.

Finally, I was enjoying you comment until you ended it with a snide comment. You should know that kind of stuff doesn't intimidate me and only makes you look bad (and will take back my Dominic comment to you because I don't want to begin talking like you).

"will take back my Dominic comment to you because I don't want to begin talking like you"

There is an edit button on here?

Which is why I'd still contend that raising interest rates right now and giving the sign that the fed will keep doing so would spur economic growth. The economy's floundering right now because consumers with money are relaxed. There's no reason to do anything. But if it looked like there was about to be an end to the incredibly cheap money they would jump on spending.

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