Tag Archives: price system

04.02.2013 | The Price System: Can You “Pay What You Want?”

In selected cities, Panera Bread is letting you decide what to pay for a bowl of turkey chili. Knowing that that the firm will cover its costs and the rest will go to charity, many people are paying more than the $5.89 suggested amount.

In 2007, the band Radiohead experimented with Pay What You Want (PWYW). For their album, “In Rainbows,” they simply said online, any amount is okay. The aggregate result was hundreds of thousands of dollars in revenue.

I wondered what was going on and checked an academic study that took me to several behavioral variables. The first was self-image. Faced with a payment option that depends solely on our conscience, we “self-signal.” The money we choose to spend reflects the “good person” we feel we should be.

However, researchers also uncovered an unexpected consequence. Self-signaling can result in fewer purchases. If the amount that retains our self-image is more than we want to spend, we simply say, “No, we won’t buy it.” We might believe we should pay $20 for that bowl of chili. But we don’t want to pay $20. Rather than diminishing our self-image, we walk away with nothing.

A bit uneasy about PWYW, I became concerned about the price system and profits.

Price System:

In a market, prices convey information. Responding to demand and supply, prices create incentives for buyers and sellers. With PWYW, the incentives are distorted.

Profits:

As for profits, I hope you will watch this Amanda Palmer TED talk and then read this Milton Friedman article. A musician, Palmer explains why PWYW is really about the trust that dominates her business model. At the other extreme is Milton Friedman saying, ”there is one and only one social responsibility of business–to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”

Do you agree with Palmer or Friedman and where does Panera fit?

Sources and Resources: Here and here are articles on the Panera PWYW initiative and here is the academic study that provides further insight.

Posted by: adminEcon
Tags: Amanda Palmer, corporate social responsibility, Milton Friedman, pay-what-you-want, price system
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03.05.2013 | The Price System: Health Care

The price system is rather amazing.

Please imagine for a moment that you heard a gallon of gasoline was $1.50. First you would think, “cheap!” Then you might rush to fill your tank. Or, told that a diamond ring was $50, you might not buy it.

Price fluctuations are called a system by economists because they move predictably in markets. Prices can be incentives and quality barometers and used to measure productivity and profitability. Just one number, a price can say so much. But not always.

And that takes us to hips.

What if you were told that a hip replacement could cost $11,000, $125,000, or somewhere in between? Sort of like learning that a wagon could be purchased for 1000 Continentals, you would not really know that those prices mean.

Recently, several college students called 102 hospitals to see how much a hip replacement would cost for their fictitious grandma without insurance. Not getting many price requests, most hospitals were not sure how to respond. When the students finally got the information, the disparity was massive. Not only did price range from $11,000 to $125, 000 but also there seemed to be no normal tie to demand, supply or quality.

In another study, researchers found appendectomies could cost anywhere from $1529 to $182,955. As for the emergency room, a study revealed that a visit for a headache could cost anywhere up to $17,797 but as little as $17. A sprained ankle? $4 to $24,110.

You know where this is going. Lacking the normal signals of the price system, medical care creates alternative incentives. And therein lies our problems.

Sources and Resources: Interesting Washington Post articles here, here and here discussed each of the three studies. Gated, here, here for hips and appendectomies and not gated here for emergency room visits, are the formal articles with all of the details. Connecting the US health care system to moral hazard, this econlib article explains the incentives that artificially low prices create.

Posted by: adminEcon
Tags: health care costs, incentive, price system, supply and demand, unintended consequences
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01.17.2011 | Toasters and Pencils

In this TED talk, a designer explains how he tried to build his own toaster. Deciding to focus on five basic ingredients instead of the 100 he would really need, he describes what happened. For the steel, first he needed iron ore. For the plastic, he went to BP to get “a jug” of oil but was unsuccessful so he settled, instead, on using potatoes. (Yes, you can make plastic out of potato starch.) Also, he needed mica and copper and nickel. As you can see, step-by-step, the simplicity of an everyday inexpensive toaster got more and more complex.

The point?

By showing how many people and materials were involved, designer Thomas Thwaites sought to display our interconnectedness.

The Economic Lesson

Now as economists, we should take his story a step further. Why are people willing to interconnect? The answer is price. During every step of the production process, someone, combining land, labor, and capital, decided that he or she would be willing to exchange a good or a service for a certain price.

So, in a way, we could say that a toaster exists because of prices and incentives. Economists call the interaction of prices and incentives the price system.

Written in 1958, a classic essay,”I, Pencil: My Family Tree as told to Leonard Read” illustrated a similar phenomenon. Close to the beginning of the essay, the pencil says, “I, Pencil, simple though I appear to be, merit your wonder and awe…Simple? Yet not a single person on the face of this earth knows how to make me…”

Posted by: adminEcon
Tags: incentive, Leonard Read, pencil, price system, TED, toaster
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01.14.2011 | How Much Should Grandma Pay?

When your Grandma gets her yearly physical, the doctor gets a check from the government. Did you ever wonder, though, who decides how much?

Because she had to sign up for Medicare at 65, the market did not decide the price and neither did her doctor. Instead, The Wall Street Journal tells us it was RUC.

RUC????

The Relative Value Scale Update Committee

Composed of 29 physicians, RUC provides a suggested price list to the federal commission that creates the Medicare Physician Fee Schedule. The WSJ says that 90% of the recommendations are followed.

Rather than the market, a committee selects the prices that convey information and incentives. Your opinion?

The Economic Lesson

Why should we care about Grandma and the doctor? Because Medicare spending now is close to 12% of the federal budget. With 30 million or so baby boomers expected to pour into Medicare during the next 10 years, and 40 more million close behind, spending will skyrocket.

What to do? Called “The Moment of Truth,” President Obama’s deficit commission report suggests that instead of pursuing “phantom savings,” Congress should implement “common-sense reforms to physician payments, cost-sharing, malpractice law, prescription drug costs, government-subsidized medical education, and other sources.” You can look at the report here.

Posted by: adminEcon
Tags: baby boomers, deficit, deficit commission, Medicare, price system, RUC
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07.07.2010 | A Pencil, An Apple, and a Price System

I suspect we take prices for granted. Please think for a moment about a $10 pair of shoes. As a consumer, that $10 price tag tells you that they are inexpensive and you won’t have to sacrifice very much to buy them. Correspondingly, seeing the same price, a shoe manufacturer might decide not to make them because profits would be minimal.

Saying prices are the reason, in Free To Choose, economist Milton Friedman (1912-2006) tells us that thousands of people, who might hate each other if they ever met, cooperate to make a pencil. Its wood, he says, probably comes from the state of Washington where they must have used a saw which required steel, which needed iron ore. The lead is actually graphite which probably came from mines in South America. With rubber from Malaya, they made an eraser and still, yellow paint and glue were necessary.

Telling a similar story about the iPhone4, the NY Times described the worldwide cooperation that created it. While the phone is assembled in Shenzhen, China, according to a “teardown” analysis, its chips come from Germany, South Korea, and the U.S., a touch-screen module is from Taiwan, and the phone’s gyroscope is made by a Geneva based company. Also involved are Japanese, Italian, and French firms and every one of them probably has production facilities around the world.

Why do they cooperate? Dr. Friedman would have said that the reason is the price system.

The Economic Lesson

In a market economy, prices that freely respond to demand and supply provide information and motivation to buyers and sellers. The up and down movement of prices is called the price system.

By contrast, in the former Soviet Union, prices were set by government created committees. As a result, they did not convey information about efficiency on the supply side nor about quality on the demand side. Different suppliers were not encouraged by prices to interact nor to cater to consumers. Lacking a price system, the Soviet economy collapsed.

Posted by: adminEcon
Tags: Free To Choose, iPhone4, Milton Friedman, pencil, price system
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