Angry about inflation? It's time you got to know rockets and feathers
It's rockets and feathers. All over the economy.
As economists and politicians keep wringing their hands about inflation, I sure wish they would read up on asymmetric price adjustment -- a phenomenon dubbed "rockets and feathers" in this 2009 paper. Prices rise faster than they fall. Inflation always "sticks" longer than economists expect because we don't have perfect markets with perfect information. Those who set prices -- increasingly, large corporations armed with ingenious, diabolical software -- are better at "bargaining" than those who pay them, particularly during shocks that lead to inflation.
The classic example: When there's a surprise disruption to the oil supply, gas prices rise like a rocket, overnight. When that disruption is solved, prices retreat slowly, drifting lazily back down like a feather. This lets gas stations squeeze a few extra day's profits out of higher prices as consumers wonder what's going wrong.
The phenomenon is well-studied in the gasoline market. Once upon a time, stuffy economists didn't believe when Main Street victims complained about it, but they now concede "rockets and fathers" is real. It's time we looked beyond gas pumps to see rockets and feathers all over the economy. It's causing a lot of suffering for paycheck-to-paycheck consumers, and among small businesses, and we should be straight with them. Large corporations are squeezing the last bit of frothy profits out of the pandemic shock, enjoying their large advantage in market information and bargaining power for a bit longer. This is why crummy train station sandwiches now cost $10,99, even though the supply chain issues of 2020-2022 are in the rearview mirror.
Look, it's scary to raise prices. Like a house party folks aren't really sure about attending, nobody wants to commit first to an increase. Price hikes risk pushing consumers away; there *always* is a price at which buyers will cry uncle and walk away. Well, it's not a single price. It's more like a curve. If you raise prices 10% but lose only 5% of your customers, you win! Still, predicting this curve is an inexact science, and you can see why many companies don't push things too far in normal times, probably leaving a little money on the table. (I love Tim Harford's explanation of pricing challenges in his book The Undercover Economist. Starbucks solved this problem by coming up with fancy-sounding drink sizes like Tall, Grande and Venti to satisfy multiple price points, he writes.)
The pandemic, however, provided an amazing real-world experiment in price hikes. Just how much *can* a grocery store push it and get away with it? It turns out, a lot, particularly if competition is limited.
So I think we are living in a golden age of price increases.
When I was working on my book The Barstool MBA, I interviewed a veteran NYC Irish pub owner who said to me there was no way he could get a double-digit price for a pint of Guinness -- $9,50 was it, he said. He believed this so strongly that he changed formats to open a cocktail bar where he was confident he could get $15-$20 for a martini and clear more cash. That conversation was pre-pandemic, of course. Those $10 Guinness are everywhere now. Even $11 and $12. Once you break into double-digits, why stop there?
If you fly, you've probably seen this phenomenon play out in real time. When one airline takes the bold step to increase bag fees from $35 to $50...competitors can't type on their keyboards fast enough to match the increase. And once an increase takes hold, well, it's open season on consumers.
Now wait, you might think -- competition is the antidote to the feathers part of rockets and feathers! Doesn't one gas station eventually lower its prices, proudly flip the numbers on its curbside signs, and watch drivers stream in? Yes, that's true, though studies show there's a kind of unspoken collusion among gas stations to hold off on such undercutting for a while. Nevertheless, it does eventually happen. That's the beauty of competition.
And that's the second half of our rockets and feathers problem.
Because there is a modicum of competition in airlines, airfares don't get out of hand unless you flying an underserved route. Airline consumers are very price sensitive, and have some search technology on their side, so that industry has been forced to invent other methods to turn massive profits -- Gotcha fees like exorbitant ticket change costs. Still, there is a free market of sorts in the airline industry. But in so many other consumer markets, a monopoly or oligopoly is at play. When you buy pay TV, or cell phone service, or broadband, how many providers are available to you?
It's true, things are better than when I first wrote Gotcha Capitalism, but competition is still limited in so many arenas. And in so many creative ways. Matt Stoller, one of my favorite monopoly fighters, wrote recently about stubbornly high hotel prices -- I'm sure you've noticed -- and unearthed a 21st-century version of collusion that you have to read about to believe. When you pull off the interstate for a night's sleep, it might appear that there's plenty of competition. But behind the scenes, many chains are using the same third-party company, and the same algorithm, to set prices. So the normal market forces don't apply. Sure, the algorithm weighs factors like seasons and occupancy rates. But it also allows hotels to work together on pricing without talking directly to each other.
It's this dastardly combination of information advantage, monopolistic behaviors, and pandemic-led "rocket" price hikes that is causing consumers and small businesses so much pain today. I'm not saying this is the cause of all inflation. I am saying that we are living in the feather portion of the rockets and feathers pricing cycle, and it's time we stopped acting so surprised when yet another government report shows prices haven't yet returned to pre-pandemic "normal." Unfortunately, we are all lab rats in the great price hike experiment and it's not over yet.
PS: If you haven't had the chance to watch FTC Chair Lina Khan on the Daily Show talk about her agency's efforts to stop monopolistic tactics that hurt consumers and small businesses, take 15 minutes now and watch. She explains these phenomena much better than I can; it's hopeful that a very public discussion about concentration of market power has finally begun.