I. The Problem

A. Background

Survey studies of attitudes toward pricing in retail markets (Kahneman et al., 1986, hereafter KKT; 1987) have reported that respondents do not consider it fair for a firm to increase prices and profits when there is a short-run change in the economic environment that is not justified by a cost increase. For example, the following hypothetical circumstances are posed (KKT, p. 201): “Question 1. A hardware store has been selling snow shovels for $15. The morning after a large snowstorm the store raises the price to $20. Please rate this action as: Completely Fair —— Acceptable —— Unfair —— Very Unfair ——.” Eighty-two percent of respondents rate this action as unfair or very unfair. What is fairness? This question is not addressed by KKT. In the light of our data, and related literature, we return to the issue of interpreting fairness in Section V.

Okun (1981, p. 170) had earlier argued that fairness considerations explain why firms operate with backlogs in periods of shortages (e.g., automobiles) and why sports tickets are often not priced to clear the market. Okun and others have argued that such instances of fair behavior by firms constitute actions which are in their long-run profitmaximizing interest: the social rules of fairness define the terms of an implicit contract that is enforced by virtue of punishment of unfair price behavior. But KKT (p. 201) argue that in many situations people report that they would follow fair policies in the absence of enforcement through punishment. Thus people report that they would leave restaurant tips (about 15%) even in cities they did not expect to visit again.