Consumer inertia: a missing link?

American Journal of Economics and Sociology, The,  Oct, 2005  by Harry I. Greenfield

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Economists and econometricians are familiar with the concept of a lag. For the most part, the lag in question is on the macroeconomic level; say, the lag between enactment of some piece of economic legislation (taxes, for example) and its effect on the economy, or the lag between an increase in investment and the (subsequent) increase in income and employment. The present note seeks to explore a lag on the microeconomic level--that of the individual consumer. There are many media descriptions of how individuals or families adjust to unemployment or, in other words, to a drastic decrease in income; in the present note, however, income as well as all the other relevant variables are equal, with the exception of price. The lag we wish to explore is one created by the time between a price increase and the consequent decrease in quantity demanded for an individual consumer. After the economic decision has been made (with information and other such costs discounted) but before the consumer commences to act, or to decrease the quantity demanded (in our special case), there is a residual period that is here termed inertia.

The "stickiness" of prices is not a new concept, having been noted by Keynes, among others. Armen Alchian pointed out, however, that Keynes "postulated a 'slow' reacting price, without showing that slow price responses were consistent with utility or wealth maximizing behavior in open, unconstrained markets" (Alchian 1977: 51). In what follows, we attempt to elucidate one factor that may help to explain this observed behavior of consumers.

Consider the following situation: a representative consumer is faced with a rise in price of a product he has been buying, even though its price to begin with is relatively high. As a law-abiding citizen our representative consumer will follow the dictate of the "law of demand" to its logical conclusion; in other words, he will purchase less of the commodity due to the price increase. How much less depends on his elasticity coefficient, which in this case we assume to be relatively low, say less than 0.5. Some degree of brand loyalty is assumed in that this consumer is not particularly interested, at least in the short term, in seeking out substitutes. (One can think, for example, of a commodity like authentic caviar.)

Does this consumer immediately reduce his purchases of the commodity, or is there a time interval during which he will continue to buy the same quantity as heretofore, even at the now higher price? I contend that the answer to the latter is in the affirmative, that is, he will not react immediately to the price change.

In static theory, with the ceteris paribus assumption in place, consumer reaction to price changes is instantaneous. In the real world such instantaneous results are almost never observed. We find instead that there is a lag in the adjustment to the new (higher) price. I submit that there is a force at work here that I shall term consumer inertia. That is to say, the consumer continues to purchase the product in the same quantity as before the price increase, even though the market dictates otherwise. The reaction time (the interval between the perception of the price increase and the rational response) instead of being zero (i.e., instantaneous) is, in fact, variable. The closer (in time) that the inertial interval is to zero, the closer we approach instantaneity and the expected behavior of static theory; the longer the interval, the greater is the deviation from expected (utility-maximizing) behavior. As here postulated, consumer behavior conforms to the two meanings of inertia: the one that states that a body in motion tends to remain in motion, in which the consumer continues buying at the higher price, and the second, of inertia as an impediment to motion, as in resistance to change.

The consumer is initially reluctant to buy three-quarters of a pound of caviar in place of his habitual pound. He is also reluctant to reduce the number of times he goes to the movies, say from twice a week to once, and there is also reluctance to alter restaurant meals from weekly to biweekly. The examples are legion, encompassing almost all items where demand for a normal good is relatively inelastic. Our term for this kind of behavior is consumer inertia, and the time it takes to change in accordance with the demand schedule is the inertial interval.

Can we determine the components of the inertial interval? One of these components I believe is habit, the tendency to continue doing what one has been doing. Another component has to do with the degree to which the individual is sensitive to external pressure. For example, reducing the accustomed quantity of caviar may result in fewer soirees with friends, which is an important part of his utility function. What is occurring, in effect, during the inertial interval is a transient transformation in elasticity from a lower to a higher level.

It should be pointed out that the concept of consumer inertia as used here is not symmetrical; in other words, a decline in price, ceteris paribus, is likely to have a zero inertial interval.