Wednesday, May 21, 2008

How microeconomic theory fails: an example from Berkeley

In the Bay Area for a couple days. I found out that it's graduation this weekend in Berkeley and that because of it room rates have gone way up. Now, why have the rates gone up? It's because there's a huge demand and not that much supply, and when that happens the people who control the supply can charge more. Whether they choose to do so is another matter. This is what the basic facts are; microeconomic theory is just an attempt to account for those facts, not, as some people claim, a science like physics. That was actually said to me by an economics teacher. So how do microeconomic theorists rationalize price gauging by hotel operators during things like a college's graduation? According to them price is a form of rationing. There are only so many goods to go around, even if there's a really high demand and people are making plans to put more of what it is into circulation later. Somehow, those goods have to get allocated. If you really want something you're willing to pay more for it than someone who just sort of wants it. So by continually raising prices on people when there's only so much of something to go around, so the microeconomists say, you ensure that the stuff goes to the people who really want it, who are willing to pay a lot of money for it.

In the case of the UC Berkeley graduation, even though there's probably a tilt towards rich families among the people coming into town it's safe to say that a cross section of society's economic backgrounds are going to be represented. They all want to see their kids graduate. Now, with raising the prices because of the high demand and the fixed supply the hotel owners assure that the rich people who can afford to pay a lot have no trouble getting rooms while the poor people who may have just been able to afford rooms at the regular rate can no longer get them in any location close to downtown Berkeley, where the University is. Both the rich people and the poorer people want to see their kids graduate, it's very important for both of them, but because of the class system the price increase shuts one group out without requiring the other group to really be impacted in order to get a room. For one group it's just beyond their capability to pay while for the other the increase is about as distressing as giving a bigger tip at a restaurant.

Under these conditions the theory that prices in a free market serve as good devices to ration products completely breaks down, undermined by class.

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