Where Does The Price Come From?

Even though prices are an essential part of the economy, surprisingly little effort goes into researching them or attempting to understand how they are set. The standard economics textbook gives only the briefest mention to the factors involved in their level. The standard summary is that prices are set in response to demand and supply. However, lately I’ve been thinking that this doesn’t quite make sense. The price of ice cream is the same in winter (a time of exceptionally low demand) as in summer (a time of exceptionally high demand). Pubs and restaurants usually charge the same prices during the day and mid-week (when they’re quiet) as during the night and on weekends (when they’re packed). In fact they seem to follow a policy of rationing space rather than allowing the price mechanism to adjust and convey information.

My epiphany came to me as I was wedged at the bar where I had been waiting for half an hour trying to order a drink during Black Monday. Why didn’t the student bar just raise its prices to deal with the excess demand which they knew would occur (as it did every year)? Why did they opt for an option that any first year economics student is taught is highly inefficient? Continue reading “Where Does The Price Come From?”

Why Wages Don’t Fall During A Recession

I have finished reading a fascinating book by Truman Bewley called “Why Wages Don’t Fall During A Recession”. It’s an interesting book not only for its topic but also for the way in which the author conducted his research. Unlike most economists who conduct studies based on complicated mathematical models, Bewley did something unusual and interviewed business owners to understand more about how they run their business. Economists traditionally viewed the market as automatically self-adjusting so that wages and prices would easily change to the right level in response to market conditions. However, it has been found that wages are rigid and almost never decline so between 1992 and 1994 Bewley interviewed 336 people in the North East of the United States (the book was published in 1999). The studies were meant to be qualitative and as such are not random or representative. They provide a very interesting insight into the mind of business managers. Continue reading “Why Wages Don’t Fall During A Recession”