After two years of the highest inflation since the 1980s, the problem of rapid price increases appears largely under control, according to most indicators. But that’s not how consumers experience it.
In grocery stores and restaurants, many consumers are still having sticker shock, and that has a lot to do with what economists call “reference prices.”
In the context of consumer behavior, a reference price is what people have come to see as the fair or normal cost for a product or service, based roughly on what they have paid for it in the recent past. That means, for instance, that paying $4 for a slice of pizza can feel like a rip-off compared with the $3 or so that many consumers were used to paying in recent memory.
“I went to get my regular crispy rice bowl and the price came out to $18 and some change!” the Reddit user can-dee, said in a recent post about the fast-casual salad chain Sweetgreen. “It used to be $15! Is this a seasonal change or a forever type of thing?! Omg. Anyone else notice this or is it just in my area?”
How it’s pronounced
/rĕ-fər-əns prīs/
Inflation for “food away from home,” as the Consumer Price Index calls it, slowed to 3.9 percent on an annual basis in September from its recent peak of 8.8 percent in March 2023. But prices in that category, and many others, are still much higher than they were in 2019, just before the pandemic hit. And once prices rise, they almost never fall back to where they were.
The Nobel Prize-winning economist Richard Thaler helped popularize the term “reference price” in his seminal 1985 paper, “Mental Accounting and Consumer Choice.” As he explained it, people often have crucial, though sometimes arbitrary, psychological thresholds for what strays too far from their reference price: a double-digit price tag for a deli sandwich, a haircut that costs more than a sit-down dinner.
During long periods of low inflation, like the 2010s, reference prices are less salient. But with a cumulative inflation rate of 23 percent over the past five years, people are still anchored to 2019 prices, even as personal incomes have increased by 35 percent over that period.
“Economists put little weight on what average people feel, but I think average people are right in the way they feel,” said Glenn Hubbard, a professor of finance and economics at Columbia University. “Inflation was so low for so long, then suddenly it wasn’t.”
In some cases, prices can go down. One way is by fostering healthy competition in consumer markets, which could lead sellers to lower prices, according to Mr. Hubbard, who was the head of the White House Council of Economic Advisers under President George W. Bush.
Regulatory reforms can also push down prices in certain sectors (like energy, insurance and housing), though such moves are likely to provoke industry pushback or political battles.
In the end, most economists agree that only time and a resettling of inflation will heal our reference price wounds — in other words, once today’s prices become the new reference.
The post When the Price of Your Burrito Clashes With Your ‘Reference Price’ appeared first on New York Times.
