An Old-Fashioned Economic Tool Can Tame Pricing Algorithms

Price-setting is a major part of the economy. Some experts worry that these programs might inadvertently learn to discriminate against minority groups and possibly collude to artificially inflate prices. A new study suggests that an economic tool dating back to ancient Rome could help curb modern concern.

The prices for entire product lines at tech companies such as Amazon and compute fares around the clock for ride-sharing services are set by an automated system. Programs may not always rely on supply-and-demand data. It is possible to use massive sets of consumers' personal information to calculate how companies can offer their most coveted products and maximize profits.

In the past few years, a number of studies have suggested that pricing can learn to offer different prices to different consumers based on their purchasing history or preferences. The strategy of personalized pricing can unintentionally lead to higher prices for disadvantaged minority groups, according to some research. One possible factor is where people live, as brokers often charge higher interest rates to minorities. Some studies show that such programs can learn to collude with one another to create price fixing schemes.

Policy makers and tech executives have sought to balance the inherent greediness of the programs when they adopt aggressive tactics in pursuit of maximum profits. A new preprint study, released online in February by researchers at Beijing's Tsinghua University, suggests that price controls are among the oldest and most elementary tools in regulating commerce.

As long as economies themselves, price controls have existed. They act as upper or lower limits on how much a seller can charge for a service. They promote fairness and protect smaller businesses by preventing market leaders from forming monopolies and manipulating prices. Over the past few years, this once common regulatory tool has attracted fresh attention due to the use of pricing strategies by ride-sharing companies. These businesses can use demand in a given area at a given time to modify their prices so drivers can make more money. This approach has occasionally spiraled into fares of several hundred dollars for a ride from an airport to a town or city, for example, and has raised calls for stronger regulation. The company maintains its support for the current strategy because it would mean lower earnings for drivers and less reliability, according to a person who asked to remain anonymous.

The idea of price controls has gained new traction due to high inflation rates. The U.S. federal government padded losses when many American businesses were forced to close. One way to control inflation would be for the federal government to limit the price a company can charge.

The authors of the new Tsinghua University paper sought scientific evidence to show that such controls could protect consumers from price discrimination and allow companies to maintain reasonable profits. The researchers wanted to know how price controls would affect producers and consumers. A surplus is the monetary benefit each party derives from a transaction. The consumer's surplus would be $2 if the true price of a good is $5, but a consumer is able to purchase it for $3.

The availability of a growing amount of consumer data has led to personalized pricing in many industries. The team analyzed the data from the published price-setting studies to see how the controls might achieve balance in the real world.

In 2002, researchers in the German city of Kiel measured consumers willingness to purchase a snack: either a can of Coke on a public beach or a slice of pound cake on a ferry. Participants in the experiment were told the price they would be willing to pay for the goods before they drew marked balls from an urn to determine the price they would actually be offered. If the original offer was higher, they would be able to purchase the snack. The experiment showed that this scenario made buyers more willing to reveal the true price they were willing to pay, compared with traditional methods. The new Tsinghua paper is a good example of the experiment's value to future studies because of its willingness to pay.

Knowing a consumer's WTP in advance allows the seller to personalize prices and to charge more to those who will be willing to pay. The purpose of pricing is to precisely estimate an individual's WTP by using data from big tech companies. The researchers used the WTP data from the 2002 study to estimate how price controls would shift the trade-off of sellers and buyers. The WTP advantage that the experimental cake and Coke sellers achieved from their knowledge of consumers would have been erased by a simple control on the range of prices considered legal. The price controls wouldn't prevent the sellers from making money.

There are some drawbacks to this balance in power. The range constraint makes it difficult to achieve a fair distribution of surpluses between consumers and sellers. According to many economists, such regulations prevent the formation of a true market equilibrium, a point where supply matches demand and consumers can receive accurate prices in real time. Some behavioral economists think that price controls can encourage market leaders to fix prices as close to the limit as possible.

For many of today's pricing agents, price fixing concerns are less important. The ability to communicate with one another is still missing from most modern pricing programs. It is difficult to forecast how an artificial intelligence program will behave when it is asked to communicate with a different design. One thing that prevents price-fixing is that many pricing strategies are wired to compete with one another, which means they value returns solely in the present rather than considering the potential for future gains that could stem from an action. In many ways, future gains could be described as greedy, although they opt to continually lower the price rather than increasing it. Artificial Intelligences that have bias tend to converge quickly to fair pricing levels.

As long as a programmer sets them up to act, they can behave ethically. It's important to study price controls because with slight changes in design, algorithms might learn to collude and fix prices. The new study says there are several research directions open. Future work could focus on how price controls would influence more complex situations, such as scenarios in which privacy constraints limit companies' access to consumer data or markets where only a few companies dominate. Sometimes the simplest solutions are the most effective.