Here is what I wrote in Class Struggles in the Information Age. Notice how much of this predates Stiglitz.
Few people without medical training have the ability to discern which surgeon is most capable. So, we are left to rely on the surgeon's reputation within the circle of people who will give us a recommendation, even though those people might be just as ill-informed as we are. People might try another strategy for seeking out the best surgeon. If prices really communicate information, the most expensive surgeon might be the best. Lacking full information about products, such as surgical services, we might think that the surgeon who charges the most must be the best. A low price might indicate a surgical lemon. This sort of reasoning was fairly common in the software market before some of the industry giants had established their now solid reputations. At the time, Robert Lefkowitz, analyst for Infocorp of Cupertino, California, observed that in the computer industry, "List price is more a statement of position rather than an economic decision" (Ranney 1985). According to another industry source, "It's similar to using a consultant. If you are paying two consultants $2.50 an hour and $1,000 a day respectively, whose advice are you going to trust more?" (Judis 1986). For example, Philippe Kahn, president and CEO of Borland, after tripling the cost of a piece of software, explained, "The product is so powerful that we were told its low price was hurting its credibility" (Flynn 1987). Similarly, Automated Reasoning Technologies of Eugene, Oregon sold a large collection of templates to run with Lotus 1-2-3. It initially priced its program at $59. Despite good reviews it did not sell well. At $89, sales went up. At $200 it was even more successful. The company concluded, "Setting a price too low can tarnish the image of a product" (Reid and Hume 1988). Tibor Scitovsky first described a similar phenomenon in 1945. He observed: ##The habit of judging quality by price, however, is not necessarily irrational. It merely implies a belief that price is determined by the competitive interplay of the rational forces of supply and demand. (Scitovsky 1945, p. 100; see also Stiglitz 1987, p. 3) Scitovsky went beyond this line of thought. He noted: ##The situation is different in markets where new models or new brands are frequently introduced. A new commodity has no traditional price, no past reputation; its quality, therefore, is likely to be appraised partly or wholly on the basis of its present price. (Scitovsky 1945, p. 101) More recently, Sanford Grossman tried to cast this attempt to learn from prices in a more abstract form: ##[O]ne is learning from prices what other people know, and that information is conceivably useful in formulating one's own tastes. At its simplest, this concerns the direct utility that one will obtain from consumption of a good. For example, if one sees that car X retails for more than car Y, then one may infer that car X is worth more to oneself, because one suspects that others have experience with this car. (Grossman 1981, p. 115) Here again we encounter the same limitations with the price system. Rather than providing clear signals to guide our behavior, the price system is often a misleading form of communication. We are often left second guessing the price system, rather than following clear and unambiguous directions. -- Michael Perelman Economics Department California State University michael at ecst.csuchico.edu Chico, CA 95929 530-898-5321 fax 530-898-5901
