How Does Inflation Change Consumer Behavior?
Inflation has put consumers in an anxious, angry mood, even as the economic data shows confounding bright spots. We asked Yale SOM’s Ravi Dhar how the perception of rising prices affects buying behavior, and how companies can respond.
Q: How does the perception of inflation affect people’s buying behavior?
Perceptions can differ from reality. I often say that people’s beliefs are not logical, they’re psychological. What that means is the perceptions of inflation are not based on actual changes in prices in the market but on the changes that draw our attention. When there are lots of news articles on airfares going up 30% or gas prices going up 50%, that makes an impression.
Overall, inflation is around 8.5% but it varies a lot across categories. To get a clear picture, economists look at a basket of commodities and what the prices were a year ago. The rest of us are really using subjective judgment based on the stuff that we know the price of which are the things that we buy frequently. Often that’s gas and groceries.
In terms of behavior changes in response to inflation, we see a variety. You look for what’s on sale which switches what you buy because different things might be on sale at different times. Another strategy is trading down, that is, you buy the store brand. Private label sales tend to go up with inflation.
With some products you postpone purchasing it. For others, you buy in smaller quantities. For still others, you buy in larger quantities because you think bulk buying is cheaper. So ironically, inflation can actually increase the quantity your purchase, in the short run, because you’re going to Costco or Walmart. People also start moving around where they shop thinking that it’s going to be cheaper at Dollar stores, Aldi, Costco, or Walmart.
You can’t make a general statement that people all buy less or trade down; it depends. For example, when people start eating out less at restaurants, they spend more on food products they’ll consume at home. Since I’m not spending $20 on fish at a restaurant this week, I can go to the store and buy not the cheapest fish, but one of the better fish. You see these fascinating changes in behavior. Taken together, there’s a lot of complexity.
Q: How should companies respond to consumers’ perception of inflation?
Again, because it’s granular, firms need to look at a specific category in which they operate and depending on what they find, they respond to inflation in different ways.
Procter & Gamble and Unilever generally have premium brands. If the premium products become less purchased, they will introduce what they call a lower tier or a value brand. If you go to Target or CVS, you’ll see the store brand highlighted and, again, sales of store brands do tend to go up in inflationary times.
“One very clever thing Costco does is to offer a few cents discount on gas. People hate to pay for gas, so when gas prices go up a lot, they go to Costco more and end up buying a lot of other stuff.”
Another thing firms do is make the donut’s hole bigger. That is, they charge the same price and offer a slightly lower quantity. The package of toilet paper will have fewer rolls. The six-ounce potato chips become five ounces which is, effectively, a price increase of 16%, but because it’s at the same price and quantity changes are harder to perceive, consumers don’t notice it as much.
One very clever thing Costco does is to offer a few cents discount on gas. People hate to pay for gas, so when gas prices go up a lot, they go to Costco more and end up buying a lot of other stuff.
Q: The economy has strengths and weakness right now—high employment, high inflation—but many people see it as worse that it really is. How can the U.S. economy improve its brand?
Again, people’s beliefs are not logical. People evaluate uncertainty based not on facts but on feelings. The classic example of this is after an air crash (unlike a car crash), many people think the risk of flying is higher than the risk of driving. In almost all cases, that’s not true. But when a plane crashes it’s in all the newspapers and television. Nobody’s processing all the facts and base rates; it’s simply, “I feel it’s not safe to fly.”
Similarly, if people I know are struggling with the cost of living, if my social media feed is all about price increases, that’ll have a negative impact on me.
Democratic leaders might want to keep pointing out that the unemployment rate is 3.5%, but if you just present facts, it doesn’t change people’s feelings. Understanding that people’s feelings matter more than facts is very frustrating for political leaders, but it has important implications for how they communicate. Some politicians are very intuitive with this. Bill Clinton had the famous, “I feel your pain” line. It’s very important to first recognize the feelings, and then to present information in a way that resonates with those feelings.