January 11, 2007
Maybe Crazy Eddie Just Didn't Understand Basic Economic Principles
The New York Times reported today on some recent scholarship entitled, On the Use of Low-Price Guarantees to Discourage Price-Cutting. If the scholarship were by someone in the humanities, that title might not provide a very good sense of what the paper is about, but the three authors, Maria Arbatskaya (Emory), Mortin Hviid (East Anglia) and Greg Shaffer (Rochester) are all economists, so the title pretty much gives it all away.
One of the things that made the eponymous (though fictive) Eddie so crazy (and perhaps led to his bankruptcy) was his habit of vowing to meet or beat any price. Economic theory tells us that the purpose of such "price-beating" promises is to discourage competitors from lowering their prices. If that is so, it makes sense for retailers to make such offers when their prices are high relative to those of their competitors, because doing so saves customers the "hassle costs" of going to another store but costs the retailer far less than an across-the-board cost reduction. However, price-beating guarantees make no sense if, for example, Crazy Eddie's prices are indeed insanely low.
Arbatskaya et al. tested this hypothesis by looking at newspaper advertisements for tires. Alas, the results indicate that retailers care not for economic theory. Price-beating guarantees are often made by the lowest-priced seller.
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