Can Micro be Weird?

Donald Bodreaux has an excellent, truly thought-provoking write-up on the imposition of price floors.

…governments also sometimes attempt to push prices upward. When the intervention is designed to increase prices by outlawing the charging of monetary prices below some minimum, the intervention is called a price floor.

I usually explain price floors to my students by speaking about attendance requirements in colleges and universities. Think of it, I urge them (only somewhat in jest), as a price that you guys have to pay me. Even if you happen to not like my classes, and think me to be the most boring guy ever – and therefore don’t wish to pay me by spending your time – no can do. You must pay me with your time.

That’s a price floor.

So what might be the unseen consequences of a price floor?

Here’s where Donald Bodreaux’s 1 column gets truly interesting (apologies for the lengthy extract):

Suppose that the government imposes a true price floor in the market for pickles. The government declares illegal all purchases and sales of pickles at prices below, say, $10 per pound (which price, let’s assume, is above the market price that would prevail absent the price floor).
The first and most obvious effect of this price floor is that the quantity of pickles that consumers are willing to buy will fall; the quantity that consumers demand will be driven lower than it would be without the price floor. If pickle producers are economically naïve, this price floor will create a physical surplus of pickles as producers, attracted by the higher price, increase their production of pickles. But even the most naïve pickle producers will soon learn that consumers are willing to buy at the high price-floor not only fewer pickles than producers are willing to produce and sell at that high floored price, but even fewer than consumers were willing to buy at prices lower than the floored price.
Discovering themselves unable to sell all of the output they are willing to sell at the price floor, pickle producers reduce their production. They produce no greater amount of pickles than consumers are willing to buy at the high price floor. So while price ceilings always create shortages, price floors don’t always create physical surpluses.
Nevertheless, because price floors do always reduce the quantities that buyers wish to buy while increasing sellers’ willingness to produce and sell, price floors create a second negative consequence – namely, the need for some means to determine which sellers will be among the lucky ones to sell at the higher price and which sellers will not be able to take advantage of the higher price by actually selling units of output at that price.
This determination might be done by luck or random chance. Perhaps only those sellers who encounter consumers early will be able to sell, while sellers who get to market too late find no more buyers.
But luck or random chance is unlikely to operate for long. Eager to sell at the high price floor, sellers will compete for buyers in ways other than cutting prices. A third negative consequence of a price floor is, thus, that the quality of the price-floored good rises. Pickle producers might attach to each jar they sell “free” coupons for discounts on crackers or deli meats or beer. These producers might work harder to make their pickles even tastier. Such non-price competition for consumer patronage is an inevitable result of price floors.
Unlike with the quality reductions caused by price ceilings, the impetus to quality improvements caused by price floors perhaps seems to be a positive consequence rather than, as I’ve described it, a negative one. But negative it is when compared to what the situation would be absent the price floor.
It’s true that, given that consumers aren’t allowed to buy pickles at any price below $10 per pound, they like their pickles being even tastier or sold with discount coupons. But what consumers would like even more is to pay a lower price for a lower-quality product. Were there no price floor in place, consumers would reveal through their spending that the higher quality isn’t worth the higher price. Yet because lower prices are unlawful – that is, because consumers must pay the higher price if they want pickles – consumers settle for the second-best outcome of paying this higher price for a higher-quality product.
Price floors, in short, compel consumers to buy too few units but too much quality. (Emphasis added)

And that’s why the title of this blogpost is what it is: can micro be weird?

Demand will go down with a higher price, sure, and suppliers will eventually reduce their supply given low demand. So far, so standard.

But remember that suppliers compete with each other, not with folks on the demand side – and so if you and I and five of our friends are pickle manufacturers facing high prices and low demand, we have to “do battle” with each other to sell our produce.

Facing low sales, will a producer’s natural response be an upping of quality? Discounts, freebies, and maybe the attempt to convince buyers that my product is of higher quality (marketing, branding) – but an actual increase in quality? But hey, that’s why studying micro can be fun – because it is weird!

This is covered in Paul Krugman’s textbook on micro too, where he cites the example of airlines upping the quality of service when faced with price floors set by international treaties. And, the textbook goes on to say, when prices were allowed to come down, so did quality.

So, long story short, yes, micro can be weird – but that’s what makes studying economics fun!

  1. quick question for grammar Nazi’s – should it be Bodreaux’s or Bodreaux’[]

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