Economics: The Culture of a Controversial Science. - book review

One of life's little puzzles is the price of popcorn in movie theaters. It costs almost as much to buy a bucket of popcorn as it does to see the movie itself. Movies cost tens of millions of dollars to produce. Popcorn costs almost nothing to produce. Why, then, is popcorn so expensive?

Most people think that it's so expensive because the movie theater has a monopoly over concessions. Since you can't buy popcorn anywhere else, the theater owner has you over a barrel. But this view assumes that moviegoers decide to see movies without considering how much it's going to cost to buy popcorn or a soda. Are moviegoers so shortsighted as to carefully consider the price of admittance to a theater but not the price of concessions?

No, say economists who have studied this issue. Moviegoers are well aware that popcorn is overpriced. But the price remains high because theater owners have learned that exorbitant prices enable them to reap big profits from moviegoers who care little about cost, while still collecting ticket fees from those who are concerned about the cost.

This practice of tailoring prices for different types of people - which economists call "price discrimination" - is common. Airlines, for example, offer a lower fare to those passengers who stay over a Saturday night. Is that because their staying over saves the airline money? Not at all. The Saturday requirement is merely a convenient way for the airline to separate leisure travelers, who tend to be price sensitive, from business travelers, who tend to fly whatever the price.

Price discrimination explains other business practices, too. Consider the ubiquitous coupon. In 1996, makers of consumer goods handed out 270 billion coupons. Why? An obvious explanation is that coupons get consumers to try products for the first time or to buy more of them. Discounted goods are enticing. But if the goal is to lure people with a lower price, why not just mark down the price at the store? It is a lot simpler to run an ad announcing a sale than to require consumers to clip coupons and remember to bring them in when they shop. Coupons also create extra work for cashiers and store managers, who must process all those little pieces of paper and forward them to the manufacturer.

So why bother with coupons? Because, economists say, they let stores price discriminate. "The supermarket's ideal pricing policy is, 'lower prices to those who would otherwise shop elsewhere,'" writes University of Rochester economist Steven Landsburg. "A practical approximation to this ideal is, 'lower prices to those with enough free time to clip coupons.'" Landsburg observes that coupons would make no sense if everyone used them. Likewise, why hand out coupons if the users are completely random? Coupons work by offering discounts to "precisely those customers who are most sensitive to price."

The point of this discussion of price discrimination is not to turn you into an expert on the subject. The point, rather, is to illustrate what economics is good for. This may be necessary, because many people don't think it's good for very much - among them is Melvin Reder, author of Economics: The Culture of a Controversial Science(*) and professor emeritus of business at the University of Chicago. According to him, there is a wide gulf between what economists think they do and what they actually do.

Most economists see themselves as scientists who doggedly - and generally successfully - pursue the traditional scientific goals of prediction and control. But Reder says, "Thus far their success in doing so has been quite limited." As the Economist once put it, an economist "is an expert who will know tomorrow why the things he predicted yesterday did not happen today."

Reder lists several reasons why predicting economic outcomes is difficult. One is that the very act of predicting Can influence the activity being predicted. Predictions of economic growth, for example, influence the investment decisions of firms, which, in turn, affect the rate of economic growth. While such feedback effects don't make prediction impossible, they do make it hard.

Another problem Reder identifies is that "in economics, far more than in the natural sciences, testing a suspect hypothesis is difficult, and usually the results are indecisive." Why are the results indecisive? Because economists, unlike natural scientists, cannot conduct controlled experiments.

Let's say an economist wants to know how much college attendance increases a person's income. It might seem that all the economist needs to do is compare the earnings of people who have gone to college with those of people who have not. But that formula is not accurate because people who have attended college are usually smarter and more motivated than people who haven't. To reach an accurate conclusion, the economist needs to compare the income of a group of people who have attended college to the income of an identical control group that has not. In the real world, unfortunately, such identical groups are hard to find. Thus economists are forced to rely on statistical measures that attempt to account for group differences. Such corrective measures are sensible, but far from perfect.