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?”