Supply and demand is a concept so simple, that even business people understand it. It just makes so much sense – businesses should want to supply things that are expensive, and consumers should want to buy more of things that are cheap, all else being equal (as a side note, people also really struggle with the ‘all else being equal’ concept – probably the subject of a future blog post).
However, in traditional economics, the two forces are separate from each other and interact in a way to determine the market price. But are they really separate? New research in behavioral economics says no.
Let’s think about how prices are really determined. In a series of experiments, Dan Ariely in Predictably Irrational determine that the price that people are willing to pay is greatly influenced by the anchor that a company establishes in the minds of the consumers. That is, if a company sets a price at which people consider buying, that price serves as an ‘anchor’ or point of comparison for other similar items. It has little or nothing to do with the ‘expected utility’ that the consumer hopes to get from the product.
It turns out that the demand curve depends more on memory than preference. There is quite a few implications for all of this, but I’ll hold off until another day in order to avoid boring people beyond their current state. Let’s just say that the next time you hear ‘it’s just good ol’ supply and demand,’ you’ll be ready to counter and sound intelligent in the process.