The Benevolence of the Baker: Fair Pricing under the Threat of Customer Anger

I suppose that an actor is considered fair if other actors cannot reject the hypothesis that the first actor is somewhat benevolent towards them. Aside from being consistent with some observations in experimental games, this approach can explain several features of pricing when consumers judge the extent to which suppliers are altruistic towards them. Under some conditions, this expectation of firm altruism can explain price rigidity while also providing novel explanations for third degree price discrimination and for the existence of “temporary sales”. ∗Harvard Business School, Soldiers Field, Boston, MA 02163, [email protected]. I wish to thank Rafael Di Tella and participants at the workshop on “Microeconomic Pricing and the Macroeconomy” hosted by the Central European University for comments on an earlier draft. “... man has almost constant occasion for the help of his brethren, and it is in vain for him to expect it from their benevolence only... It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love...” Adam Smith, The Wealth Of Nations Adam Smith was surely right in proclaiming that suppliers’ hope for material gain provides the main impetus behind the supply of goods. However, this still leaves open the question of whether the benevolence of suppliers plays any role at all in market exchanges. Certainly, many firms spend resources proclaiming this benevolence towards their customers. Johnson & Johnson, for example makes an effort to tout its 50-year old one-page “corporate credo” which begins with: “We believe our first responsibility is to the doctors, nurses and patients, to mothers and fathers and all others who use our products and services. In meeting their needs everything we do must be of high quality. We must constantly strive to reduce our costs in order to maintain reasonable prices.” Shareholders are mentioned last, and the credo ends with the words “When we operate according to these principles, the stockholders should realize a fair return.” It is conceivable that this firm is just “burning money” through this publicity, but too much effort is spent emphasizing the content of this message to make this interpretation plausible. At the same time, consumers also appear to care about the benevolence of the firms that they deal with. Consumers irate over price gouging often accuse the offending firms of being “greedy” and “selfish”. A consumer who responded to a gas station that raised its prices after the September 11, 2001 attack by picketing the station (and thereby leading the station to close) complained that the station had failed to honor the idea that “most Americans come together in times of trouble. This overt anger at price gouging is reflected in interview surveys where subjects are asked what prices they would consider “fair”. Kahneman, Knetsch and Thaler (1986), for See, for example, http://www.jnj.com/our company/our credo history/index.htm. “Quick Stop in Waunakee is picketed” Wisconsin State Journal September 13, 2001.