Advanced macroeconomics: Solutions manual by Romer D.

By Romer D.

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Example text

The demand curve has a negative slope, which means the higher the price, the less the customer buys. There are exceptions to this situation, however, which give rise to apparently irrational consequences. In his classic The Theory of the Leisure Class, the American economist and sociologist Thorstein Veblen revealed way back in 1898 that prices signal status and social prestige and therefore offer the buyer an additional level of psychosocial utility. This is known as the Veblen or “snob” effect.

Higher prices also mean that demand goes down. The demand curve, therefore, has a downward (negative) slope. The point where the two curves intersect is known as the market-clearing price, the only price at which supply and demand are in equilibrium. Equilibrium means that every supplier willing to sell at that price can sell his or her desired volume, and likewise every buyer can find his or her desired volume at that same price. In a market with free supply and free demand, a market-clearing price always emerges.

34 3 The Strange Psychology of Pricing bought it in the past. The explanation is simple. 11 The less a buyer knows objectively about the quality of the products and prices in an assortment, the stronger the pull of the “magic of the middle” will be. One could even argue that this purchase behavior is rational, as the buyer tries to make the best possible decision with very limited information. By selecting a product from the middle of the price range, buyers simultaneously reduce the risk that they buy something of poor quality and the risk that they overspend.

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