Catalog of clever ideas: Prices

We ought to use them more

How many bagels should be baked in New York tomorrow?

Suppose you were commissar of bagels and had the job of determining how many bagels should be baked each day. How would you arrive at your determination?

You could survey potential customers. You could analyze consumption patterns in the past. You could extrapolate from bagel consumption in other cities.

Or you could do nothing at all. You could let the bagel makers and the bagel eaters work the matter out among themselves.

But what if they got it wrong? You could lose your job if there are too few bagels or too many. In the case of the former, there would be angry calls to City Hall from hungry bagel-deprived New Yorkers. In the case of the latter, the complaints would come from the bagel makers who have unsold bagels on their hands. Bagels don't keep.

But you have an ace up your sleeve. Your orders are to match bagel supply to bagel demand. Your orders say nothing about how much the bagels should cost. Again, you will leave that up to the bakers and the eaters to work out.

Your experiment begins. The bakers arrive for work at 3 a.m., as usual. The first bagels come out of the ovens at 6. The most eager customers are there waiting, and they are willing to pay premium prices. As the hours pass, sales slow. Bakers adjust their prices, progressively lowering them. By mid-afternoon, the bakers are almost giving away the bagels, which will soon turn into hockey pucks. At closing time, nearly all the bagels are gone.

Congratulations, commissar!

Actually, if you were a commissar, as in the Soviet Union, things wouldn't have worked this way. You would have given orders that a certain number of bagels would be produced, and that they would be sold at a certain price. And if you were like other commissars, your orders would have resulted in empty shelves by noon or unsold inventory at day's end.

The first price was negotiated when some prehistoric hunter decided he was tired of eating venison. One of his fellows had killed several ducks. Give me one of your ducks, he said. The duck hunter replied: I will if you give me that deer of yours. The deer man answered: A deer will feed you a lot longer than a duck will feed me. The duck man countered: You're right. I'll give you five ducks for your deer. And so the sale was made.

The details of this fable are doubtless wrong, but it captures the essence of how prices work. Which is to say that if prices are to work, they have to be a matter of negotiation between buyer and seller. When such negotiations are allowed to occur, prices are a marvelous device for matching supply to demand.

Negotiations aren't always obvious in America's everyday economy. If I go to the grocery store, I don't haggle with the butcher over the price of his meat. The price is posted, and I take it or leave it.

But prices change. If the butcher doesn't sell much meat today, the price tomorrow might well be lower.

Of course there are additional constraints. Butchers and other suppliers have costs they have to cover. These include the prices they pay to their suppliers. Decisions on prices are part of a web of decisions, with each influencing the others.

Haggling over prices is less common in America than in some other countries, but point-of-sale adjustments occur in various contexts. Auctions are one example. In this case it’s not the buyer and seller negotiating, but competing buyers. Airlines and promoters of concerts employ dynamic pricing, which algorithmically adjusts prices to suit demand. Prices go up if many people want a seat on a particular flight or at a particular concert. They go down if few people do.

Firms that take bets on sports contests do the same thing. If most bettors are betting on the Lions against the Rams, the firm adjusts the point spread or odds to make the Rams more attractive. The firm wants the bets on the two teams to balance out. It makes its profit on the fee it charges for each bet.

Ride-share companies like Uber and Lyft likewise set prices according to demand. If demand is high, they raise prices. Here the incentive aspect of prices is clearest. Higher prices cause more drivers to make themselves available for riders.

Dynamic pricing is sometimes called surge pricing. It’s also called price gouging by people who don’t like it. If I’m used to paying 40 dollars for a ride from the airport and suddenly I have to pay 100 dollars, I’m not happy.

But if I wait a bit, the 100 dollar fare will bring out more drivers and the price will fall. If, on the other hand, the fare is fixed at 40 dollars—by municipal ordinance, say, as often happens with traditional cab companies—I might have to wait forever for a ride. In New York, where fares to the airports are often fixed, I’ve had cabbies drive away when I said I wanted to go to JFK. During rush hour they didn’t make enough—even with a rush hour surcharge—to compensate for the time it took. They weren’t supposed to refuse riders, but they did, understandably.

Resale markets often employ dynamic pricing. If you buy a concert ticket at the box office or its online equivalent, you might pay a sticker price of 100 dollars. If the concert turns out to be really popular, you sell it for 200 dollars or more.

In practice, you don’t buy one ticket but twenty or a hundred. You might make a lot of money on resale. But if the concert turns out to be unpopular, you lose a lot.

In some states this practice, called scalping by its critics, is illegal and has to take place in the shadows. But it provides a service to people who didn’t think ahead or know until the last minute they’d be able to attend the concert. The alternative to paying a higher price is not being able to attend the concert. That wouldn’t make your Swiftie granddaughter happy.

Many states have “anti-gouging” laws against dynamic pricing in the retail and hospitality sector. A merchant can’t jack up the price of bottled water after a hurricane. Hoteliers can’t quadruple their rates when Taylor Swift comes to town.

These laws are popular. People don’t like to feel they’re being taken advantage of. But the laws can be counterproductive. If a malfunction in the water system in Austin provokes a run on bottled water, I might borrow a truck and drive to San Antonio to purchase it there, for resale back in Austin—but only if I can charge enough to cover my costs and pay me for my time and effort. If the law keeps me from charging the higher price, the people in Austin are going to go thirsty.

Not everything has a price, including some things that ought to. Industrial activities that polluted air and water historically avoided paying for the damage they did. In recent decades these activities have increasingly been regulated, with caps placed on emissions. This often isn’t the most efficient way to reduce emissions. An alternative is to put a price on the emissions. A factory has to pay X dollars for the right to emit a ton of sulfur dioxide into the air, for example. This is usually called a tax, in that it is collected by the government. But it’s really a price.

Anti-pollution technology is expensive. Mandated caps can drive small firms out of business. Pricing pollution would let some of them stay in business, by paying the pollution tax instead. Because they’re small, the amount of pollution that would be permitted by this means would be small too. The big firms would pay to install the scrubbers, because that would be cheaper for them.

Pollution pricing applied to carbon dioxide emissions is called a carbon tax. And though some states have imposed carbon taxes, they’ve never caught on at the federal level. Partly this is because polluters, like other people, don’t like paying for what they previously got for free. Partly it’s because environmentalists sometimes express an ethical objection to letting polluters buy their way out of doing the right thing.

Another advantage of pricing pollution, or any other obnoxious activity, is that it doesn’t require omniscience on the part of regulators. Set a price and measure the response. If it doesn’t reduce pollution by the right amount, adjust the price.

Mandates are what commissars issue. Pollution commissars are no more likely to be successful than bagel commissars. And they’re no more necessary.