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People Don’t Understand Prices

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Washington University economist Ian Fillmore sent to me the following insightful e-mail about public attitudes toward so-called “price gouging.” I share it here, in full, with Ian’s kind permission.

Hi Don,

I just saw this NBER working paper [2] that surveyed people’s attitudes and beliefs about price increases. I wonder if there might be some insights here for those of us who oppose price gouging laws (and other forms of price controls) regarding which types of arguments are likely to be persuasive with the general public (My impression is that these laws exist precisely because they are popular.). In particular, my anecdotal experience says that many people view prices as being arbitrarily set by businesses. When I ask whether McDonald’s, say, could charge $1000 for a hamburger, I’m usually greeted with “Of course not! Don’t be absurd!” even though I’m just restating their logic back to them. This tells me that many people have very fuzzy and logically inconsistent notions about where prices come from.

Why do consumers, who interact with markets every day, have essentially no idea where prices come from? I think it’s because they have zero incentive to learn. If I’m a price taking customer buying in a competitive spot market, then all that matters to me is the price. I could have a crazy theory about where the price comes from that involves the phases of the moon and the appetite of my pet cat. Or I could have a sophisticated theory based on supply and demand analysis. The market won’t punish me for my crazy theory any more than it will reward me for my sophisticated theory. In many areas, knowing something makes you better at it. Knowing about ocean currents and weather patterns makes you a better sailor. Knowing about chemistry and physiology makes you a better pharmacist. But knowing about supply and demand does nothing to make you better at grocery shopping. This is one of the virtues of free markets–they require precious little economic knowledge from their participants. On the other hand, this is one of the great challenges of economic education. People have little tangible incentive to learn and understand economics.

Ian Fillmore

DBx: I agree. And thus a challenge to all competent economists is to better explain to the general public the formation of, and the indispensable role played by, prices. Ian is correct that this lesson is not one that the public is seeking to learn. Indeed, it’s a lesson that the public actively resists. Yet because markets among strangers work only insofar as prices (including wages) are free to rise and fall to reflect the prevailing conditions of supply and demand, the greater is the public’s acceptance of market-driven changes in prices and wages, the better for society.