Academic journal article Economic Inquiry

Why Do Firms Contrive Shortages? the Economics of Intentional Mispricing

Academic journal article Economic Inquiry

Why Do Firms Contrive Shortages? the Economics of Intentional Mispricing

Article excerpt

Economists typically inveigh against government-imposed price controls, finding them and the shortages they create to be Kaldor-Hicks inefficient.(1) But not all observed shortages result from government price controls. When firms experience sudden changes in costs or demand, they sometimes voluntarily but temporarily refuse to clear the market rather than alter prices.(2) Depending on whether the temporary price is above or below market-clearing levels, a firm's intentional refusal to alter price forces potential buyers or sellers to queue, so that rationing is required and both the firm and its clients incur additional costs [Barzel 1974]. When the abnormal events pass, mispricing and rationing disappear as well. But price alteration was always open to firms in those situations, and no widely accepted price-theoretic explanation exists for their insistence on mispricing.(3) That is the phenomenon investigated in this article.

Economists' inability to derive a convincing model of episodic mispricing, and in particular to test various models using conventional empirical methods, has begun to spawn new theories at variance with received economic doctrine (e.g., Basu [1987]; Kahneman, Knetsch and Thaler [1986]). One recent study by Blinder [1991] has addressed the problem through interviews, in the belief that price stickiness can be explained by asking business executives themselves for the reasons. Though preliminary, that study has already attracted substantial attention.(4)

Those few, more orthodox price-theoretic inquiries into voluntary mispricing fall into two distinct categories. In the first category, researchers model inventories and order backlogs in which all participants are ignorant of present or impending market supply and demand, due largely to stochastic features of markets.(5) Inventories or backlogs are expectable, because it is not economic (or possible) for market participants to predict market supply and demand with precision. Indeed, in some of those situations the apparent queues are not even real. For example, De Vany and Frey [1982] show that where production processes are especially time consuming, apparent queues are actually a listing of forward orders by buyers who would not even want delivery at present.

By contrast, in the second category, no participant need be ignorant of impending market conditions.(6) Rather, queues arise either because buyers prefer to consume some products (restaurant meals, rock concerts, athletic events) as part of a crowd [e.g., Becker 1991]; because under-pricing of some goods is preferable when the alternative is other buyers just taking the goods [Cheung 1977]; because the cost of waiting in a queue is low relative to the cost of continuously adjusting price (e.g., ski lifts [Barro and Romer 1987] or peak-time telephone service(7)); or even because--jumping outside price theory--ill-defined ethical considerations interdict market-clearing price adjustments (e.g., following catastrophes [Kahneman et al. 1986]).

A third logical category exists--one in which participants on one side of a market are substantially better informed about market conditions than are participants on the other. That third category is the one studied here. In retail markets, sellers are able to ascertain the nature and likely duration of market alterations more often than are buyers. In upstream markets, some buyers survey a larger part of the market than do sellers, and so are in a better position to interpret market conditions.

Logically, the analysis here would apply to both situations, but the examples that we consider are of the former sort. Thus, this article considers situations in which perfectly informed sellers tolerate shortages that cost them money in the short run in order to protect long-term, profitable relationships with consumers who are not as well informed.(8) The analysis is based upon a conventional price-theoretic model and specifies empirical tests showing why and how profit maximizers nevertheless run shortages intentionally. …

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