In their book Animal Spirits, George Akerlof and Robert Shiller discuss (amongst much else) the phenomenon of ‘fairness’. In the wake of Hurricane Andrew, vendors declined to put up the price of plywood – although both demand and costs for the good had risen.
They claim this was a response to the precept of fairness, and how consumers react to behaviour which they deem to be ‘unfair’. In fact, traditional economic models have just underestimated the ability of individuals to manipulate the market.
Anti-trust law has arisen partly in response to collusion by firms to extort profit from consumers and reduce competition. Traditionally though, economists don’t consider consumers to have the ability to manipulate prices.
If firms are deemed to exploit consumers by pricing their goods and services in an ‘unfair’ manner though, they are punished – losing public regard and custom. It could be explained by consumption smoothing, as firms absorb losses now and push up prices later.
If consumers acted in an individually self-interested manner, there would be no such phenomenon. They would base their present and future purchases on the individual respective costs and benefits.
Rather, they sometimes manage to co-operate by punishing firms that have an overtly dominant market position. Firms respond to this, by not price-gouging or otherwise exploiting consumer misfortune.
In the perfectly competitive world, this couldn’t happen. Are consumers being irrational by allowing ‘fairness’ to alter their consumption path? Not at all.
The behaviour is perfectly rational from the group perspective, when analysed on the aggregate level. In any economy, it is likely that there are markets in which bargaining power is concentrated with suppliers (in the minority) at the expense of buyers (in the majority).
Because of this asymmetric distribution of gains from trade, most people stand to gain from the concept of ‘fairness’. In effect, consumers are forming a cartel – agreeing to refuse custom under certain circumstances to firms who are exhibiting too much market power.
They might stand to lose out as a group, and indeed individually. But as a policy, it’s extremely effective. Together, consumers have the capacity and bargaining power to collectively force fair prices out of firms.
These firms (such as the Home Depot in the initial example) are powerless when confronted with consumers arranged against them. How can consumers enforce this cartel though? It is still advantageous individually to bail.
In practice, consumers are probably punished using the very same social mechanisms (“I can’t believe you still shop at Wal-Mart since they put that grocers out of business”). How we got to this point is another story entirely.
This may prove difficult to explain, as we would have to turn to evolutionary psychology. Analogies might be drawn with the civic duty of voting – individually irrational, but society has manufactured a negative sum game where non-voters are socially punished.
The fairness precept has so engrained itself now, that behaviour motivated by its demands are deemed simply ‘animal spirits’. Although further analysis would be necessary to determine its origins, it’s far from irrational. Rational self-interest will truly go to extraordinary lengths.
© The Free Marketeer 2009