Have you ever noticed that the price of gasoline changes almost daily, but the price of a haircut stays the same for months or even years? This isn't random. Some prices are volatile, while others are remarkably stable. Understanding why is the first step in understanding how prices are actually set in the real world.

For a long time, economists relied on abstract theories to explain this. Then, an economist named Truman F. Bewley decided to try something different. Instead of just looking at data, he went out and talked to the people who actually set prices: business managers, executives, and small business owners. His book, Why Wages Don't Fall During a Recession, is based on hundreds of these interviews.

One of his key findings was that businesses are very reluctant to lower prices, a phenomenon called "price stickiness." Why? Managers worried that cutting prices would signal that their product was low quality. They also found that frequent price changes annoyed loyal customers, who value predictability. It was often better to keep a stable price, even if it meant selling less for a short period, than to risk alienating the customer base.

Bewley's work also highlights two crucial concepts that give companies control over their prices: product differentiation and market power.

When a company successfully differentiates its product, it's no longer selling a simple commodity. A customer isn't just buying a smartphone; they're buying an iPhone. They're not just buying coffee; they're buying a Starbucks latte. This uniqueness gives the company more flexibility in setting its price. It's not forced to match the lowest price on the market because its product offers something others don't.

This leads directly to market power. Market power is a company's ability to influence the price of an item in the marketplace. A wheat farmer has virtually no market power; they have to accept the going rate for wheat. In contrast, a pharmaceutical company with a patent on a life-saving drug has immense market power. The more differentiated a product is, the more market power the company that sells it tends to have.

Managers who have more market power can afford to think about customer morale and long-term relationships, just as Bewley discovered. They aren't trapped in a day-to-day battle over pennies. They can set a price that they believe is fair and sustainable, and then hold it steady.

Now, let's test your understanding of these core pricing concepts.

Understanding these foundations—price stickiness, differentiation, and market power—is key to grasping how companies navigate the complex world of pricing.