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Some Economics of Pricing in the Real World

In my latest column for AIER I explore some basic economics of pricing in a world – our world – in which there are costs of transacting. (This column is the first in what will be a two-part series.) A slice:

Consider supermarkets. Nearly all supermarkets offer customers ‘free’ parking, despite the fact that building and maintaining these parking lots is costly. These costs are recouped in the prices supermarkets charge for groceries. Yet not all supermarket customers use automobiles. Some customers walk to the supermarket. I live within walking distance of a Whole Foods store, and so although I shop there frequently, I never use its parking facilities. Other customers take taxis or public transportation.

Are non-parking customers, myself included, being ripped off by the fact that part of the prices we pay for groceries is used to enable supermarkets to supply free parking to other customers? Of course not. In a world in which all transactions are costly to carry out – which is our world – it’s simply not worthwhile for supermarkets to identify non-parkers and then to determine just how many pennies should be shaved off of their grocery bills. That is, the costs that supermarkets would incur to prevent me and other non-parkers from ‘subsidizing’ parkers would be so great that, should supermarkets attempt this task, their total costs of operation would rise. Supermarkets would have to raise grocery prices for everyone, parkers as well as non-parkers.

So why don’t supermarkets charge customers to park?

Food retailing in the U.S. is intensely competitive. Because of this reality we can be sure that the value to consumers of ‘free’ parking paid for in the form of higher grocery prices is greater than parking-for-pay combined with lower grocery prices. Determining exactly why this outcome is so is, for us, unnecessary. But the likely reason is that, for supermarket customers, the transaction costs, reckoned in terms of time and inconvenience to each customer of paying out of pocket for parking, exceed the costs of paying for parking in the form of higher grocery prices. Charging directly for parking would thus result in less shopping at supermarkets. Some stores might become uneconomical to operate, while stores that remain open would raise prices to cover electricity, managerial salaries, building rent and maintenance, and other overhead expenses.

We can be pretty certain that if government forced supermarkets to stop non-parkers from ‘subsidizing’ parkers, the total costs of groceries would rise for everyone.

Similar reasoning applies to merchants that accept payment through credit cards. If government forced these merchants to stop customers who pay with cash from ‘subsidizing’ customers who pay with credit cards, merchants would have to spend resources on this costly effort. It’s not only grocery retailing in America that is intensely competitive; almost all retailing is so. Merchants – and there are indeed many – who do not offer cash discounts have discovered, or have good reason to believe, that the costs of offering such discounts exceed the benefits.

Note that merchants have incentives to offer cash discounts whenever doing so would raise their revenues by more than any accompanying increase in costs. The reason is that cash discounts enable merchants to attract more poor customers – a desirable outcome even for (indeed, especially for) the greediest of merchants. So the fact that relatively few merchants offer cash discounts reveals that, were government to compel the offering of such discounts, merchants’ overall expenses would rise by more than their revenues. To cover these higher expenses, prices would rise, including those paid by poor customers.

Another way of putting the above conclusion is this: Merchants that accept credit cards (even ones with bonus points) typically find that the lowest-cost way to serve consumers is to charge the same prices to customers who pay with cash as are charged to customers who pay with credit cards. (That some merchants do give cash discounts proves that experimentation is occurring!) My guess is that this typical policy of not giving cash discounts results in more sales than otherwise and, thus, better ability for merchants to spread total overhead costs more thinly, with the result being overall lower prices even for customers who pay exclusively in cash. Or perhaps not. Maybe there’s some other benefit to this policy, one that no armchair economist, think tank researcher, or magazine reporter is informed enough to detect.


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