Asking About Prices: A New Approach to Understanding Price Stickiness.

• Author: Denslow, David

By Alan S. Blinder, Elie R. D. Canetti, David E. Lebow, and Jeremy B. Rudd. New York, NY: Russell Sage Foundation, 1998. Pp. xi, 380. $34.95.

Assisted by 13 graduate students in undertaking 200 face-to-face interviews, Alan Blinder asked executives who set prices for nonfarm, for-profit unregulated firms, "If you cut your prices by, say, 10%, by what percent would you expect your unit sales to rise?" An astounding 40% replied that unit sales would not rise at all (p. 99). Is this result a second prong - the other being the claim by David Card and Alan Krueger that lifting the minimum wage does not reduce employment - in a Princeton attack on one of our most cherished beliefs, the law of demand? Can it be that so many "real business people," as Blinder often calls them, think the elasticity of demand for their products is zero?

Possibly uncomfortable with this implication, Blinder notes that his question may be unclear about whether rival firms would also reduce their prices. Some executives may have been estimating elasticities of demand facing their industries, not their firms. Even so, are we to take their answers seriously? Do they think their industry demand curves are vertical? Do they have in mind an instantaneous short run in which quantities are fixed? Are they thinking of dynamic effects, whereby reducing prices leads consumers to expect further reductions? Are they misled by an identification problem, associating price cuts with leftward shifts of demand curves instead of movements along them?

Also striking are the responses to the question "How would you characterize the behavior of your own variable costs of producing additional units as production rises?" Two-fifths of the respondents report that their marginal costs are declining, though, as Blinder notes, they may be mistakenly thinking of average rather than marginal costs. Only 11% said their marginal costs were rising. The remainder reported they are constant.

Discovering perceived elasticities of demand or marginal costs was not the goal of the survey. Its purpose was to test 12 theories of why prices are sticky. But if you bring to this book a strong prior belief that violations of the law of demand are rare and doubt that declining marginal cost applies to 40% of gross domestic product (GDP), you may wonder whether the respondents understood what other questions intended to ask. If simple concepts, elasticity and marginal cost, raise a communications barrier between...