Price Stickiness, Policy Stickiness – Econlib

Perfect markets make for great fairy tales, but they don’t match reality. And the straw man that has been killed as repeatedly as the idea that the market argument depends on the integrity of the market, and that it is therefore inevitable that real-world markets will not match this textbook abstraction, is that the market This undermines the argument for using Some of the strongest advocates of market systems, such as F.A. Hayek and Israel Kirzner, reject the idea of ​​perfect markets, perfect information, and perfect competition. Their discussion of market exploitation is not based on the abstract perfection of markets, but on the real-world dynamism inherent in ongoing and evolving market processes. Markets are useful not because there are no $20 bills on the sidewalk in a market-driven world. Markets are useful because they create the right environment. find That 20 dollar bill.

One of the real-world frictions in real-world markets is price stickiness. In the fairy tale version of the Perfect Market, prices adjust instantly. In the real world, prices can be static, sometimes they don’t change, and sometimes they change slowly. One reason for this is transaction costs. Price changes may not be free. This is a textbook example of so-called “menu costs.” Restaurant prices are fixed and may not change, even as the costs of various foods and ingredients change. To change prices, the restaurant must print a completely new set of menus with updated prices for each dish. This costs money and time. If the price of potatoes increases slightly, it’s often not worth the time and effort for the restaurant to print a new menu set with updated prices for all dishes that include potatoes.

However, like asymmetric information, transaction costs also have a half-life. Markets have an incentive to find ways to reduce transaction costs and reduce price stickiness. Because finding ways to reduce transaction costs is itself a money-making opportunity. Another example is menu costs. One way I’ve seen restaurants avoid menu costs is by not displaying prices on certain menu items. If a restaurant in a beach town frequently serves fresh, locally caught fish or lobster, the cost of those items can vary significantly. To accommodate this, menus often list such dishes as “market price” rather than a set price.

Lately, we’ve seen many other restaurants display their menus on digital displays rather than print them. Some restaurants have also done away with physical menus entirely and replaced them with QR codes on each table. Scanning the QR code with your smartphone will open a website with an updated menu. This significantly reduces transaction costs associated with menu pricing and makes prices more flexible. Price stickiness is a real problem, but at the same time, the very existence of the problem motivates the market to find a solution. Hence Arnold Kling’s maxim: “Markets fail. Take advantage of the market.”

On the other hand, there are also problems with the tenacity of the policy. When a government makes a policy to solve some social problem, the policy itself becomes sticky. People tend to overlook this issue surprisingly often. A great book by James C. Scott look like a nation Provides a detailed look at how policy interventions fail. Toward the end of the book, he offers several points that may help improve the situation:

Prioritize reversibility. Prioritize interventions that can be easily reversed if they prove to be a mistake. Irreversible interventions have irreversible consequences. Interventions in ecosystems require particular caution in this regard, given how little we know about how ecosystems interact. Aldo Leopold captures the spirit of caution required: “The first rule of smart tinkering is to save all your parts.”

In the abstract, this isn’t bad advice. However, the idea that an intervention can be easily reversed if it turns out to be a mistake becomes less persuasive when one considers that policies are also rigid. In practice, it is often very difficult to undo an intervention, no matter how wrong it turns out. As Pierre Lemieux has frequently pointed out, government policies stick because they inevitably benefit some at the expense of others. This quickly turns into a matter of national choice. As soon as a government implements an intervention, new interest groups are created that are invested in keeping the intervention alive, while the benefits of stopping the intervention are highly dispersed, making it particularly difficult to stop the intervention. No one has a strong incentive to do so. put an end to it. No wonder Milton Friedman quipped, “Nothing is more permanent than a temporary government program.”

This joke exaggerates things. Not all policies are so entrenched that they become immovable. But that’s the real problem. One classic example is mohair subsidies. The program was originally implemented to ensure that the U.S. military always had a supply of suitable wool for its uniforms. Eventually, however, the military stopped using this wool in its uniforms and began using synthetic materials instead. Nevertheless, the federal government continued to spend tens of millions of dollars annually in subsidies for mohair production long after the initial rationale had disappeared. This program was finally (mostly) phased out more than 40 years after the switch to synthetic materials.

this A 1993 report describing continued efforts to eliminate these subsidies included comments from Sen. Charles Schumer, who said he had spent years trying to reverse this policy. It states that If you had a policy that should be “easy to undo,” you’d think this should be as easy as possible. But policy persistence is so powerful that even something as seemingly simple as “stop spending tens of millions of dollars a year on subsidies for things we no longer needed decades ago” can ultimately lead to It will take years of concentrated effort to achieve this goal. pace According to James C. Scott, “interventions that can easily be reversed if they prove to be wrong” exist only in fairy tales, not in real life.

Markets provide incentives to find ways to offset and reduce price stickiness, while politics provides incentives for policy beneficiaries to make that policy as sticky as possible. In the market, you can profit by finding ways to reduce transaction costs. In the world of politics, huge profits are protected by keeping transaction costs as high as possible. In the real world, price stickiness is proverbial speck And policy tenacity is the proverbial log.