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Pricing and the Myth of the Single Market Price
(Part of a series of articles on pricing.)
Last time I discussed how the factor of time interacts with large-scale production and prevents prices from falling to the seller's marginal utility, and that the time preference of buyers is in harmony with the seller's desire to maximize revenue.
It is an obvious fact, but worthy of emphasis, that prices are set by people. There are different ways to set a price — through an auction, by haggling, simply announcing a price, etc. — but in all cases prices are set and changed by people making judgments based on the information they have. Information about present conditions and predictions about future conditions are both extremely important.
At this point it is necessary to dispel one of the unfortunately widespread misconceptions about prices: The idea that there is, or should be, a single market price for all equivalent units of a good or service. Single market prices are mythical, they exist only by an arbitrarily narrow consideration of the scope of a market. I do not mean to deny the pedagogical usefulness of the idea, which clearly has enormous value, but I do object to the widespread omission of reminders that it is a simplifying assumption that seldom holds in the real world.
Think about the last time you bought even a very homogeneous good like gasoline. You've surely observed that different stations charge different prices for the same grade of gasoline — even stations on the same road only a few blocks apart, or merely across the street. Their prices are sure to be similar, but seldom identical. There is no single market price.
(Indeed, if many different gasoline stations charged identical prices, conspiracy-minded people would accuse them of collusion. If a single market price indicates "collusion", while the lack of one indicates a failure of markets to be "efficient", then all possible outcomes are unacceptable. When no outcome is acceptable, it is your theory — not reality — that is wrong.)
Financial markets are another excellent example. The price of a stock changes continuously during the day, and the changes are extremely rapid. There is no price stability. Ten transactions for stock in the same company could occur within the span of one minute, each at a different price. These prices are all most certainly market prices, but it is utter nonsense to describe any of them as the market price. There is no single market price.
Transportation costs create another example to chase away the illusion of a single market price. Identical goods are often more expensive in Alaska and Hawaii than in the continental United States, because the cost of transportation affects the final price.
Defenders of the single-market-price religion would counter that Alaska and Hawaii shouldn't be considered part of the same market as the continental United States. They would also claim that stock prices are stable over a suitably small interval of time, and that each gasoline station constitutes its own market. (Think I'm exaggerating? Last year the FTC launched an antitrust case over the super-premium ice cream market.) These excuses are nothing more than deliberate myopia, an arbitrary narrowness in considering what constitutes a market, providing no value beyond putting some lipstick on the single-market-price pig.
The Alaska/Hawaii case does have a veneer of credibility, so I do have some sympathy for it, but ultimately it is arbitrary as well. If location is a factor in determining what a market is, we're on a slippery slope. Even after dropping Alaska and Hawaii, why consider the entire continental U.S. the same market? Why not divide also at the Mississippi river, and again at the Mason-Dixon line? Why not along the borders of every state? Every county? Every road? Then we reach the conclusion that every gasoline station is a separate market, the ridiculousness of which has already been mentioned.
Reality does not consist of discrete markets. Substitutes and alternatives are pervasive on every scale.
I hope I have succeeded in overcoming the educational/institutional bias toward single market prices. In the next installment I will discuss why a single market price is undesirable in some circumstances.