With the Economic Downturn and Wages Stagnant, What Economic Rationale Prevails for Increasing Prices?

BY Business Desk  January 27, 2009 at 11:37 AM EDT

Woman shops; AP photo

Question/Comment: In the New York Times recently, it was stated that there has been a drop in consumer prices. Here is NYC I have found that prices have risen. For example, a half gallon of milk that was $1.89 three months ago is now $2.19; movie tickets for seniors have gone from $8 to $9 in January.

With the economic downturn, wages stagnant, what economic rationale prevails for increasing prices?

Paul Solman: Who needs a rationale? A company (or individual) will generally charge as much as it can get. Economics, however, says that a company (or individual) will ultimately be able to charge only as much as its “marginal cost.” Stick with me here; this is something everyone should know, even though it’s probably not true in the real world.

Say you and I make “shires” (shirts made out of retreads). What can we charge? Only as much as the competition. (Or so goes the theory of competitive markets.) What does the competition charge? As little as it can.

So the question becomes: What’s the least that a shire maker can charge? The answer: the cost of producing the very next shire. (This is because the previous costs don’t count. They’re already incurred, known in business as “sunk.”)

Now in real life, as I say, this “law” of economics is violated on a daily basis. Partly that’s because most firms don’t operate in purely competitive markets; there are monopolies and near monopolies, for example, due to patents or just getting bigger faster. There are, in fact, all sorts of market distortions.

But if you and I make milk instead of shires, chances are that our pricing policy is pretty much at the mercy of the competitive market. Same goes for movie tickets. MOST prices, however, HAVE BEEN going down. Look at the price of gas. Or grain. Or steel. Or clothing. And for what it’s worth, I’ll bet milk prices will come down too. Even movie tickets. And especially (just a guess now) high-priced sports tickets.