Fellow economics blogger Tim Harford over at Dear Economist has taken on the placebo effect of prices. This is particularly exciting to me because I did my undergraduate honours thesis on this topic.
The placebo effect of prices basically says that as a product's price goes up, it becomes more effective because of some psychological process. Some of the key studies on this topic so far have been in the medical and marketing literatures. The placebo-effect-of-prices topic has yet to gain much attention from economists, so it's nice to see Harford (an economics writer with the Financial Times) is aware of it. It's also fun to see the practical applications of academic research being presented.
I believe the placebo effect of prices is something that deserves a little more attention, because if higher prices do make products work better, this needs to be taken into account when governments and central bankers are considering policies that change prices. Inflation may have a positive effect that we are currently ignoring, for instance, if it makes everything we purchase better. However, the placebo effect of prices is a fairly new area of study, so we are only beginning to understand how it works.
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Hmmm, I would say economists, policy makers and governments would have to be very careful with this information. It sounds like someone could use it to justify increasing prices with an agenda other than the welfare of the public.
ReplyDeleteI can especially see this information used by drug companies as a facade for their prices, which actually are a huge part of explaining Canada's high health care costs.
If anything, I would say this information should be used to "test" the knowledge of the public. If there is indeed a strong placebo effect, perhaps being better educated on the matter would be better.
Just a few thoughts...
certainly an interesting topic, but I don't see how an across the board inflation would have the positive effect? If it's relative prices that consumers face, then straight up inflation wouldn't change anything, would it? If an increase in the nominal price was enough, wouldn't we see higher levels of utility in times of hyperinflation? My understaning was that the higher price doesn't make the product better, but it adds an element of decadence which has an added utility of it's own.
ReplyDeleteEcon Artist, I agree with your points. I don't think the placebo effect could be used to justify all cost increases, since even if there is a positive placebo effect, it would be offset by not being able to purchase as great a quantity of the product at the higher price. I believe some studies have shown that alerting people to the possibility of a placebo effect makes it go away somewhat, so I think your intuition about educating the public is probably correct.
ReplyDeleteMatt, you raise an interesting question. I don't think the literature on the placebo effect has looked at relative price increases yet. So it's unclear whether there'd be a utility gain from a nominal price increase if relative prices were held constant (e.g. inflation).
As for whether or not we'd see higher utility levels during hyperinflation, probably not. If there is a relative price placebo effect, we'd see that create higher utility. But that would probably be offset by utility loss from the costs (e.g. menu costs, problems stemming from lack of confidence in the currency) attributed to hyperinflation.
As for whether the higher price makes the product better or whether there's a decadence effect, I think it's a matter of perception. If U=quality+price decadence, as you suggest, we could get the same result as if U=quality(price), as I suggest. Ultimately, I don't think we could ever observe which it is. But in both cases, the point is that utility changes from the price of a product.