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An Economic Puzzle: Fixed Prices with Variable Unit Sizes

By Tom W. Bell and Glen Whitman

I?ve finally succeeded in inserting the code to make post extensions work (with the help of Hackosphere), so this seems like a good time to pose an economic puzzle I?ve been thinking about.

In the absence of price controls, most goods and services respond to changes in conditions with changes in price, while the size of each unit remains fixed. If grain gets more expensive, for instance, the price of bread rises while the size of loaf stays the same. But can you think of any goods or services for which the price remains fixed while the amount per unit changes, even when the prices are free to fluctuate? I can think of two or three. Can you guess what they are, and can you come up with any others?

The example I had in mind was marijuana. Though I have zero personal experience with buying weed, I?ve seen the transactions take place, and some friends (you know who you are!) have confirmed my observation. Marijuana is typically sold in amounts designated by price, such as the well-known nickel bags ($5) and dime bags ($10), as well as larger $50 or $100 bags. If there?s a change in supply conditions, like the cost of growing weed, it is apparently reflected in the quantity per bag. Likewise, if you?re buying better quality weed, that will be reflected in a smaller volume in the bag, not a higher price. You don?t see bags of weed with prices like $19.95.

And there?s a natural economic explanation, courtesy of Ronald Coase: transaction costs. An illicit market puts a premium on fast and discreet transactions, because longer transactions increase the chance of getting busted. Nobody wants to take the time to make change, and that makes it desirable to have prices easily represented by one or two bills.

This explanation suggests a second example, with which I?ve had even less experience: prostitution. I don?t know for sure, but I?d be willing to bet that prostitutes always price their services in denominations of at least $20, and probably $100. The reason is the same: minimizing the time involved in making the transaction. I can?t imagine there are any hookers who charge $349/hour.

And the topic of sex suggests a third example, this one legal, but still characterized by high transaction costs: lap dances in a strip club, which seem to be priced in $10s and $20s. In that context, nobody wants to spend time fumbling with change, especially since (a) the dancers don?t usually have pockets and (b) the cash mostly comes straight from the ATM, which dispenses cash in $20s or higher.

Am I missing any other examples? And do they all have the feature of high transaction costs?

Full post as published by Agoraphilia on June 15, 2008 (boomark / email).