AISHANI BANERJEE – NOVEMBER 10TH, 2020
EDITOR: AYDIN MAHARRAMOV
Introduction
Two weeks into March of this year, the United States declared a national emergency. You can probably guess why.
You can also probably guess what happened to the economy directly after this acknowledgment of the pandemic and the threat it posed. It doesn’t take an economist to tell you that if nobody wants to go out to buy food for fear of contracting a lethal virus, demand for food falls. And as demand falls, prices adjust downwards with it.
The US was very vulnerable to this phenomenon, something which the country only realized the day the pandemic made its way to the shores of Washington state. Food chains have been consistently optimized for efficiency; as a direct consequence of this, our supply chains are fragile as glass. All it took was a push for things to begin spiraling.
Prices were in freefall for several months. Export fish and shellfish dropped by a whopping 17% from January to June, while dairy and eggs dropped down by almost 12% in May. Corn, which suffered more from its reduced role in energy manufacturing than a shift in consumer preference away from corn on the cob, took a hit after the oil embargo dropped the demand for ethanol.
In general, it had not been a very good year for food. Even after dairy bounced back from May to June, rising in price by 24%, the speed at which the sticker prices in a local grocery store change serve to underscore just how fragile and volatile the supply chains that we’ve built for a modern-age are.
Perishables like meat and dairy are obviously some of the most susceptible to these moves. It’s in the name: because they’re perishable, they have to be constantly bought and replaced, making it that much less shock-absorbent of a good.
But what if you wanted to buy a pack of bubblegum? Let’s say you’re looking at a pack of 15 count Wrigley’s Cinnamon Gum (or whatever flavor you happen to prefer most if you can’t stand the taste of fake cinnamon). It’s always in the same location in every grocery store or supermarket: impulse purchases next to tabloids and chapstick. And it’s almost always in the same general price range of right around one US dollar.
That’s weird. That’s very weird, especially considering that Wrigley’s is a global manufacturing plant. In fact, it is the largest chewing gum manufacturer and distributor in the world, and has many factories in China, basing heavy parts of its supply chain on the origin point of the pandemic. Six months into the pandemic and still, the cost of a pack of gum hasn’t changed at all.
Why is the price of gum so sticky?
Sticky Prices: An Introduction
In economics, price stickiness refers to when a good, for whatever reason, doesn’t obey the basic law of supply and demand and doesn’t change in price, even if the supply suddenly increases or the demand dries up. In a perfect market under perfect competition, this wouldn’t exist. But we don’t live in perfect markets.
Prices can be sticky for a number of reasons. Housing, for example, especially in a place like Berkeley, can be inflexible downwards, and therefore “stuck” at the higher price even after a significant drop in demand.
Because Berkeley enacts rent control, landlords are hesitant to adjust their asking fees, despite a pandemic and online learning significantly reducing the number of renters in a university-town who they could be selling to. It’s a pretty logical concern: rent control makes it so that year after year, the rent can only be raised by a certain and fixed percentage.
If landlords slash the price 10, 20, even 30% in hopes of attracting just a little more demand, once the pandemic is over, they’re stuck still renting out their units at pandemic-prices. They can bring the price down easily, but raising the price up again another 10% is forbidden under the rules of rent control. Ergo, most landlords have to make a decision. They have to place their bets on how long the pandemic will last and decide if they can hold out not renting for those months, or if they have to bite the bullet, lower their rent, and make reduced income for decades afterward. The vast majority of landlords have picked option A, which makes sense—that would be the rational decision, supported by economist-logic.
This explanation doesn’t work so well when we consider gum. No law in the US states that Wrigley’s can never raise their prices whenever they want. In fact, most economic thought operates under the assumption that Wrigley’s can and should be sensitive to price changes, considering it operates in an oligopoly, locked mostly in competition with Warner Lambert Co, which produces Chicklets, Trident, and Dentine.
Coffee and a Cautionary Tale
Perhaps part of the reason can be explained from a cautionary tale, one you may know if you’ve ever spent enough time around old enough veterans. During WW2, American soldiers stationed overseas would go to comfort stations operated by the Red Cross and get cups of coffee and donuts for free.
Then, the Red Cross raised the price of their donuts by two cents, and veterans have sworn off them ever since. A two cent price hike, something like the equivalent of seven nickels in modern-day America, and for seventy years since, veterans have disliked the Red Cross. That would be enough to make any multinational corporation think twice.
However, other companies can hike prices without any problem. Anecdotally, bubble tea has steadily been rising in price in the Bay Area for the past five years, going up often twenty-five cents at a time, without a dent in demand. What happened for the Red Cross?
Well, in their instance, it wasn’t so much about how high they hiked the price. It was more about what it was before. See, before the Red Cross sold donuts and coffee, they used to give it away for free, and a price of 0 is, for reasons unknown to economics, special.
Psychologists, however, or really anyone with a passing understanding of people, could tell you why “free” is so special. Zero is a unique number, and people overreact to it, often in very irrational ways. When you give something away for free, the price of 0 gets associated with its value in a way that a price of $1.99 or $15 might not. More than that, the relationship between the seller and the buyer of a free object is fundamentally different from the relationship between the seller and buyer of objects with prices attached to them. By changing the price of donuts from 0 to 0.02, veterans of WW2 weren’t reacting to the price change itself (a thirty-five cent donut today is still a pretty good deal!) Rather, they were reacting to the fundamental nature of their relationship with the Red Cross being changed.
So why even bring up this example, if it’s special in a way that Wrigley’s gum is not? There was never a moment in time when a 25-pack of cinnamon gum was simply given away by Wrigley’s to free for consumers, and therefore, it should be possible for them to adjust their prices as much as they want, without worrying about the reaction from consumers. Right?
Seventy Years of Nickel Coke
Mentioned earlier was the fact that Wrigley’s operated in an oligopoly, which means this article would be remiss without addressing perhaps the most famous of all oligopolies: Coca-Cola and Pepsi. After all, it’s not necessarily true that a firm in an oligopolistic market will react to demand shifts according to the traditional supply and demand graphs.
It seems like Coca-Cola specifically has been subject to a very similar situation to the donuts. For years, Coca-Cola marketed itself as the cheapest soda alternative to the more expensive seven or eight cent competitors, and it pinned the sum total of that advertising onto one specific fact: for almost seventy years, it cost only a nickel to buy a coke.
That’s a tough fact to really appreciate. Even knowing that those 70 years included two world wars and the Great Depression, it’s hard to put into perspective the fact that this price could stay constant through all of that. Partially to blame is the human cognitive bias known as the money illusion. The money illusion posits that humans have a very tough time thinking of prices or money in real terms, and instead default to thinking of money nominally. Translated, that means that we, as humans, find it difficult to factor inflation into our concept of money. It’s just plain hard; even if you know that inflation in the US has held steady at 2-3% for decades, for our brains can’t turn that into “our money halves in value every 20 years.”
That kind of thinking ticks over into how we think about prices. Even though we can all be aware that we live in an economy that has inflation, it’s very difficult to remember that when looking at how costs rise in our daily lives. In general, we get used to thinking of objects as having a certain set price. We’re used to the fact that a pack of gum will cost about a dollar, more or less. That’s a nominal price. But it’s very hard to think of the cost of that pack of gum rising, even if the inputs, like sugar or xanthan, can change in price and are absolutely susceptible to inflation.
There are a whole host of reasons why Coke cost a nickel from the years 1886 to 1959. Part of the reason was the simple fact that the vending machines could only handle nickels and no other coins, so there was no way to raise the price without doubling it. Another reason had to do with the long history of the right to bottle Coke, and a tricky advertising campaign from the syrup producer’s part to keep the bottlers from selling coke for more than five cents a pop.
Perhaps the most important reason? If a product has a price for so long, it becomes part of the brand. The same way a price of “0” can become an intrinsic quality to both the product and the seller, given enough time, Coca-Cola could develop the sort of relationship with their buyers that nearly guaranteed the 5 cent coke. It started as advertising, and ended up as branding, and not just any kind of branding. Coke was the “cheap” soda fountain sort back in the late 1800s, and, as we all know, a lower price leads to more quantity demanded. Branding themselves as the affordable option worked out for Coca-Cola, and they had the demand to prove it. Coke is, even today, cheap and ubiquitous.
Years later, it seems like the same strategy is working out for Wrigley’s. Cheap, affordable, the kind of item you expect to see in the impulse purchases section of the grocery store, next to tabloids and chapstick. The price of Wrigley’s gum communicates something about the item it is. Just like donuts from the Red Cross were supposed to be gifts for service, and Coke is the cheap, one-nickel soda at the fountain, cinnamon gum has a price that communicates something about it.
A pack of gum is the sort of thing that will always be a dollar. Gum isn’t a useful commodity, and it has no nutritional value; you’re literally told not to swallow it. Most people who find themselves running low on the gum that they carry in their backpack or purse won’t actively seek it out or add it to their grocery lists, and you don’t add gum to recipes or do anything special with it. It has one use, and one use only.
It’s a sort of thing that you, the buyer, will look at, look at the price, then go “oh, why not,” and put down next to the items you actually came to buy. Gum is, intrinsically, an impulse buy. And Wrigley’s, the seller, knows it. That’s why the price of gum won’t rise or fall: a dollar is just the right amount that you won’t miss after you’ve gotten a whole cart of actual groceries.
Featured Image Source: Food Business News
Disclaimer: The views published in this journal are those of the individual authors or speakers and do not necessarily reflect the position or policy of Berkeley Economic Review staff, the Undergraduate Economics Association, the UC Berkeley Economics Department and faculty, or the University of California, Berkeley in general.
