Why are product prices quick to rise, slow to fall?

By Tod MarksConsumer Reports

If you follow the news, you’ve probably heard that the cost of gasoline has dropped significantly after reaching a six-year seasonal high in June. But if you’re like me, you probably wonder why actual prices at the pump don’t seem to be falling nearly as rapidly as they should.

Back in 2010, the Federal Trade Commission’s Bureau of Economics released a working paper—designed to heat up debate—as to why retail gas prices seem swift to rise when, say, crude oil futures increase or geopolitical tensions flare, but drift down slowly when the conflict ends or oil futures take a tumble.

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The phenomenon is so well known that the industry has a name for it: “Rockets and feathers.” Others call it “sticky” pricing. And it’s not imaginary. The FTC paper concluded that retail prices, on average, rise more than four times as fast as they fall.

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Many supermarket products are subject to the same illogical price fluctuations, particular products containing commodities such as wheat, rice, corn, soybeans, milk, and eggs.

During the recession, commodity costs sank like a stone, though supermarket prices didn’t decrease nearly as fast and, in fact, the price of some goods, such as ice cream, kept climbing.

Similarly, many airlines and even hotels retained fuel and energy surcharges long after fuel costs decreased. Some of those charges are still around today.

Such inexplicable shenanigans make it easy to understand why so many of us are quick to shout conspiracy. Why do companies maintain higher prices on goods even after the basis for the increases no longer exist?

Companies typically price their goods based on what the competition is charging, not necessarily on what it costs to make them, experts told us. The first company to hike prices runs the risk of losing customers to a competitor that holds the line. On the flip side, if one company decides to undercut a competitor it could ignite a price war. So there’s a lot at stake.

Another reason companies are hesitant to drop prices is concern that the good times won’t last. Sure, gas prices are lower now, but inevitably they’ll rise again. By maintaining the existing price, the theory goes, companies can avoid antagonizing consumers down the road and beef up their revenues in the meantime.

There’s also a behavioral component as to why companies may be reluctant to lower prices. professor John T. Gourville of Harvard Business School says it has to do with a phenomenon known as “loss aversion.”  In a nutshell, that means people tend to find more pain in price increases than pleasure in price decreases.

In other words, if you hike the price of a gallon of milk by $1, for example, it causes a louder commotion than $1 drop. And once consumers become accustomed to the new, higher price, the retailer or merchant may be better off maintaining the price there than lowering it, only to have to raise it again.

—Tod Marks

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