Price Discrimination Explains...Macro?
In chapter 10 of Macroeconomic Patterns and Stories, Ed Leamer writes,
in recessions, the most price sensitive customers drop by the wayside, and what remains are the wealthy who don’t care much about price. Facing this kind of customer base, firms have little incentive to cut price.
He is trying to tell a story to explain the old macroeconomics conundrum. Why do recessions manifest themselves in terms of quantities rather than prices? Why don’t prices adjust to clear markets?
When I wrote that Price Discrimination Explains Everything, it did not occur to me that it explains macro. In that post, I suggested that stores encounter shoppers on Black Friday who are more price-sensitive than customers on other days, so they lower they offer sale prices on Black Friday. Here, Leamer is suggesting that stores have their least price-sensitive customers during recessions, so they do not lower their prices. I worry that this is a just-so story. In recessions, aren’t non-rich customers likely to become more price-sensitive?
If you don’t like that story, Leamer has some others to offer.
Most of us love our homes, and have a hard time dealing with the idea that the market value is less than we think. To adjust to a reduced market price can be tough emotionally.
The result if that in a housing downturn, the volume of transactions plummets. With flexible prices, you would expect to see the same volume–just at lower prices. Leamer offers a similar argument for why people will not accept wage reductions.
A different Leamer story is that employment is closer to a relationship than to a market. When you are making hiring and firing decisions, small differences in the wage rate do not mean much. If you really don’t want to go out to eat with a guy, how much difference would it make if he offered to split the check 60-40 instead of 50-50? By the same token, if you really do not want to hire someone, how much difference would it make if that person would take a 10 percent lower wage?
In a way, this is an “animal spirits” theory of employment. Keynes argued that investment was not very sensitive to the interest rate, because the “state of long-run expectations” of the entrepreneur was more important. Similarly, if labor is capital, then the state of long-run expectations determines your willingness to hire, and hiring is not very sensitive to the wage rate.