President Biden needs an economics lesson. Demonstrating his ignorance of economics, his recent State of the Union speech regaled us with a laundry list of legal business pricing strategies that he wants to see restricted or banned by federal agencies such as the Consumer Financial Protection Bureau (CFPB) and Federal Trade Commission (FTC).
These pricing strategies include what Biden pejoratively calls “junk fees”, “shrinkflation”, “greedflation”, “surge pricing”, and “price gouging”. Both American businesses and consumers are targets of Biden’s barbs, as he blames the former for inflation and the latter for their stupid gullibility to businesses’ evil ways.
But he fails to understand that successful businesses carefully survey customers’ preferences and behavior when designing pricing strategies, and that they cannot risk antagonizing or disparaging their customers.
Basic Principles of Economics that Biden Needs to Know
Biden has plenty of White House economists who can provide his economics lesson. Both the Council of Economics Advisors and the National Economic Council include members whom he personally appointed, as well as many professional support staff members. But here are some basics that he needs to understand.
Peak-pricing and Off-peak Discounts
Peak-load pricing and off-peak discounts are pervasive throughout the economy. Businesses attempt to maximize revenue and profit if they want to stay in business, and price-setting mechanisms have traditionally been left to individual firms’ judgment based on knowledge of their markets. Some businesses offer products and services at base prices, with additional voluntary add-ons to give customers some choices that may generally produce overall lower prices for consumers. Other businesses choose to price their offerings at higher all-inclusive prices that may result in generally higher prices but often at greater consumer satisfaction.
For example, AT&T for many years offered traditional telephone service that provided only local-area dialing for a regulated base monthly rate, accompanied by higher long-distance service priced separately and scaled by time of day. But technology now offers telephone service providers competitive options, such as cell phone service that includes unlimited calls anywhere for one flat monthly rate. Would today’s phone customers choose the former telephone service with its separate charges for local and long distance calling, or do they prefer the higher-priced unlimited all-areas calling? Based on ubiquitous cell phone usage, the answer is obvious.
Movie theaters have long offered discounted afternoon matinee tickets at lower prices than evening tickets, a price differential that most movie goers ungrudgingly accept. The matinee and evening audiences see the same movie as evening patrons, munching the same theater popcorn. But years ago theaters and other entertainment venues discovered that afternoon audiences exhibit a more elastic (that is, more price-sensitive) demand for movie-going than evening audiences do. Offering an afternoon matinee discount thus gives theaters the opportunity to increase revenues by showing the same movie in the afternoon to capture customers who might not otherwise attend at all.
The same analysis applies to senior discounts on services, where such discounts are easier to implement than on products because sellers must be able not only to identify seniors but also be able to prevent them from buying products and then “reselling” to non-seniors. Sellers of movie tickets, public transportation, and many other services can easily offer senior discounts, which are a form of price discrimination that represents virtue-signaling to seniors but also maximizes sellers’ revenue.
Note that there is nothing illegal about such price-setting strategies. Nor are there currently any regulatory restrictions on these strategies.
“Junk Fees”
A favorite phrase among politicians is “junk fees”, which Biden has disparaged and vowed to ban. His targets include excessive bank overdraft charges, termination fees for canceling cellphone and cable internet contracts, processing fees for hotel bookings, late credit card payment charges, and airline bag fees or extra charges for parents to sit next to their child on a flight.
Congressmen have spoken up about junk fees. In March 2023 Senators Blumenthal (D-CT) and Whitehouse (D-RI) introduced the Junk Fee Prevention Act to eliminate hidden fees that cost Americans billions of dollars annually.
The FTC in October 2023 announced a new proposed rule to prohibit bogus junk fees that can “harm consumers and undercut honest businesses”. The proposal would prohibit businesses from charging hidden fees by requiring them to include all mandatory fees when quoting a price for a good or service. The FTC has estimated that these fees can cost consumers tens of billions of dollars per year in unexpected costs.
The CFPB has chimed in to stop new junk fees such as non-sufficient funds fees at point of purchases using debit cards.
And state governments are speaking up too. On October 7, 2023, California Governor Newson signed Senate Bill 478, which takes effect July 1, 2024. The law will ban what it calls “drip pricing”, the practice of advertising goods or services at one price and then adding mandatory charges or fees later in the sales transaction. While it is still unclear how this new law will be implemented, many expect that service businesses like restaurants may choose to automatically add surcharges or leave that choice to customers. It is unclear how this law will be applied and enforced.
Portmanteau terms “Shrinkflation” and “greedflation”
Politicians have recently applied these disparaging terms to two major items in consumers’ budgets: grocery store food packaging and gasoline at the pump, items that consumers purchase regularly and whose prices they follow closely. In using these terms, politicians attempt to lay the blame for price inflation on producers and retailers.
President Biden used these terms in his State of the Union speech, blatantly ignoring the role his own administration has played in causing price inflation.
“Surge Pricing”
This relatively new term recently appeared in reports that fast-food chain Wendy’s was considering higher prices for its menu items when restaurants are busy and lines are long, that is, during normal mealtimes. Rumors spread rapidly that this would discriminate against people who either preferred or were required to eat meals during traditional mealtimes, backlash that led to the chain’s quickly retracting the proposed pricing policy.
But the economics behind the policy is well-founded and pervasive among sellers. Electric utilities, for example, have long charged higher energy prices during times of high demand such as summer months when customers run air conditioners. And “smart meters” now allow utilities to charge higher electricity prices for periods of high demand such as early evening when customers are home from work and preparing dinner. Many utilities now offer customer options for TOU (time of use) or TOD (time of day) pricing, or have defaulted customers into this pricing. The economic rationale for this policy is avoidance of investment in expensive new generating capacity to serve peak energy demand, leveling the load on generating and distribution facilities and thus lowering overall costs for all rate-payers.
“Price Gouging”
This ostensibly occurs when producers and retailers may increase prices if certain items become scarce, as some sellers did when the pandemic interrupted supply chains. Sellers must often increase prices after natural disasters such as tornados or hurricanes. These increases properly serve as a rationing device that equalizes supply and demand.
Price increases in these circumstances are a natural response to scarcity, and a free market will effectively allocate scarce resources to those who need them the most. Deliberate or greedy price gouging per se simply doesn’t exist.
Why Politicians Blame Businesses (and Consumers) for These Pricing Strategies
Politicians blame businesses for high prices (and consumers for being gullible) in order to win votes. But their own mistaken policies are often the underlying cause of inflation. In Biden’s case, his March 2021 American Rescue Plan increased federal spending well past the time when additional stimulus was needed, thus incurring more federal budget deficits and increasingly high debt, placing more spending power in consumers’ hands on top of earlier stimulus payments in 2020. It’s a wonder that inflation did not increase more than it in fact did.
Let’s hope Biden doesn’t become so smitten with his efforts to banish these pricing legal mechanisms that he starts advocating price controls. If he does, his economic advisors must be prepared to teach him a good long lesson about what happened in the 1970s when the Nixon administration implemented price controls prior to his 1972 re-election campaign. Instead of quelling what was then about 6 percent annual inflation, those price controls contributed to a decade-long run of high inflation that subsided only after the Federal Reserve raised interest rates as high as 20 percent in 1980, with unemployment approaching 10 percent. engineering a deep recession to wring inflation out of the economy.
