Price asymmetry and my bus ticket

A large debate in economics stems from the idea that there is a price asymmetry in the economy. What this implies is that prices are more flexible in one direction (up or down) then they are in the other direction.

The commonly provided example is petrol prices. People feel that when crude oil rises in price it is passed on immediately, but when it falls in price it takes time for the firm to react and lower petrol prices. This implies that prices are “stickier” downwards, and so the adjustment to two shocks opposite shocks is asymmetric.

Another example is housing. People find it psychologically difficult to accept that the nominal value of their house has fallen, so it tends to be harder for the nominal price to fall than for it to rise.

Now there are a large number of economists that don’t believe these asymmetries exist (I’m in the camp that I think the downward asymmetries are exaggerated). Overall studies have been inconclusive.

Now I think sticky prices exist, but I think we’ve also got an inherent bias to look at cases where they appear to be sticky downwards compared to stick upwards. I was reminded of this when I brought my Gold Pass for the bus in September.

Now, before September the Gold Pass was $95, now it has been increased to $99.  However, standard fares increased by an average of 11%-33%.  Every other ticket type is pinned to the increase in standard fares – expect the gold pass, which increased by just over 4%.

Unless demand for gold passes is significantly more elastic than demand for other fare types (which I highly doubt – given that people who buy gold passes are the people who are most likely to have made specific investment in a lifestyle that involves a bus, eg by not buying a car) this seems nonsensical.

However, it does make sense when we think about nominal rigidities on the upside for the price of a good.  $100 is a psychological barrier for people – if the gold pass was to go over $100 a large number of people may react and stop buying passes.  In this sense, demand for a gold pass IS highly elastic at $100 given this.

As a result, there is an upside asymmetry.  Prices are unable to rise as far as they should to make the allocation of resources efficient, because of this “nominal rigidity”.

How is that rational?

This may sound like irrational behaviour, however it fits into a category that economists call “bounded rationality“.

One way to think about this is as follows:  People make decisions about what mode of transport to take, and then they stick to them irrespective of the price, because there is a transaction cost associated with re-evaluating the choice of travel all the time.  However, when prices pass some psychological barrier (fuel goes past $2/lt, or gold passes cross $100 a month) people take this as a sign to re-evaluate their transport decisions.

In this way, when a nominal price hits a certain value act as a signal for bounded rational people to “re-optimise”, and in turn this leads to a disproportionate change in quantity.  This change in quantity and price is efficient – as it involves the individuals in society making choices based on what is in their best interest (and assume that any market failures are taken care of), however at some level it is not in the firms interest, which is why they do not adjust the price.

Conclusion

My bus ticket is a sure fire sign of nominal rigidities – the very factors that make inflation costly by ruining the relative price signal in the economy.

It is also a sign that price asymmetry holds on the upside – as well as on the more heavily documented downside.  Namely, some firms are slow to adjust prices up just like some firms are slow to adjust prices down.