I’m currently reading Scarcity by by Sendhil Mullainathan and Eldar Shafir. At this stage, I’m inclined to sympathise with the unnamed colleague who commented “There’s already a science of scarcity. It’s called economics”. So far, it’s mostly straightforward applications of the observation that time and attention are scarce resources, combined with some fairly familiar observations from behavioral econ on how people fail to optimise either the first-order problems of allocating a tight budget or the second order problem of allocating time and attention to the first-order problem (my terms here, not theirs). However, I’m only part way through, and the authors promise to show how their approach differs from the way in which economists would normally think about this kind of problem.
This post is about a specific and well known observation cited by Mullainathan and Shafir. Faced with paying $100 for an item that could be had elsewhere for $50, most people are willing to put in a fair bit of effort (say, driving for an hour) to get the lower price.[^1] On the other hand if the item costs $1050 and could be had for $1000, people with reasonably high incomes mostly pay up, instead of driving to the other store. This is obviously inconsistent with standard opportunity cost.
But, it seems to me that there is an obvious and justifiable heuristic at work here. I buy $50 items fairly often, so if I regularly end up paying $100 for them, the purchasing power of (a large section of) my income is halved. On the other hand, paying a 5 per cent surcharge on $1000 items won’t have a big effect. It follows that it’s worth a fair bit of mental and organizational effort to work out ways of paying the $50 price rather than the $100.
The critical assumption in this argument is that, having secured the low price on one occasion, it will be easier to do the same in future.
Once you see this, you can improve a bit on the heuristic. For once-off purchases, at whatever price, you may as well pay a premium price if the mental and physical effort involved in getting the low price outweighs the premium. So, if you’re in a strange city you don’t plan to revisit, and faced with a cab fare that’s double the fair price, it’s probably better to pay up than to work out how to reach your destination by bus.[^2] In your home town, it’s a totally different matter.
Update As Richard Coppola points out in comments, xkcd is all over this. Check the infinite regress in the mouseover.
[^1]: Depending on your circumstances you may need to adjust the number. And one of the neat observations by Mullainathan and Shafir is that poor (US) people, to whom $50 is a significant cost at any time, are not only more willing to put in the effort, but less prone to change in response to a change in the total price.
[^2]: I haven’t always taken my own advice on this.
{ 32 comments }
David (Kid Geezer). 10.22.13 at 5:24 am
Actually, Google maps on your phone probably reduces this decision time penalty to just a few minutes at most and renders your example problematic.
bad Jim 10.22.13 at 5:57 am
If something’s cheap enough, being economical doesn’t add up even for frequent purchases. I dither over tissues – surely Kleenex doesn’t deserve its price premium – and generally buy the box with the least annoying design. A penny saved is ridiculous.
Meredith 10.22.13 at 7:00 am
Now that I am older and wiser, I can prepare a nutritious meal for pennies. (Wish I had been better at that when I was less experienced and poorer.) Fortunate as I am now, I am more likely to prepare a nutritious meal for dollars. Were I less fortunate, I would make better use of my accrued parsimonious wisdom (though a lot of the parsimony remains, inculcated).
Many variables at play here is all I am saying.
bad Jim 10.22.13 at 8:03 am
Expertise is a great multiplier, and a meal is the sort of good whose quality is easy to judge, which may not be the general case. I don’t regret the hours I spent on auto repair and plumbing, and the reason I mostly let professionals do such jobs now is that they’ve gotten beyond me. When I lift the hood on new car I’m stupefied; it doesn’t look like an old VW. When tree roots emerge in my toilet I’m forced to admit that my little snake won’t do the job.
Having the tools and the expertise to handle problems short of these is the result of a certain amount of investment of time and money which made sense during my parents’ lifetime and some of mine, marking me as solidly middle-class, hippie heritage be damned, likewise later wealth.
I believe it’s obligatory to mention that my dad bought a dishwasher in the late 1950’s with a bonus he got for filing a patent (or so he said). It was as big as the ones we have now, but it rolled around on wheels and had hoses connecting it to the sink. There was general agreement that it was a good thing.
Andrew Smith 10.22.13 at 8:48 am
I turn off whenever I see the horrid phrases “life hack”, pro-tip”, etc Even when they are written by John Quiggin.
Mao Cheng Ji 10.22.13 at 10:01 am
I know people who will always buy the more expensive of two almost identical things, because they believe that price necessarily correlates with quality.
Teena Lyons 10.22.13 at 10:23 am
I’ve got to agree with Mao Cheng Ji… Many people correlate price with quality, even if this isn’t always the case between the two options… However, if no other information is known about the products then you can see why some people think that price should reflect quality (and in that case why some people then often end up paying way over the odds)
Pete 10.22.13 at 10:31 am
” Google maps on your phone probably reduces this decision time penalty to just a few minutes at most ”
.. although exposing you to a kind of risk that the Google map is not the Google territory. It may take far longer than it says on the screen to travel for money saving purposes.
(Maybe I’m just bitter at having to drive round half of Essex in the middle of the night because of a few very strategically closed motorway exits that Google were not aware of)
Alex 10.22.13 at 11:00 am
Is this really inconsistent? There are probably any number of ways you could get a 5% discount – if you’re spending $1k, just looking like you’re thinking of walking away ought to do it; getting a 50% discount is rare (scarce, in fact) and you ought to grab it.
Metatone 10.22.13 at 12:14 pm
Perhaps it’s my Euro-hippy living style, but driving for an hour seems to have the potential take a big chunk out of the $50 saving.
I’m curious though, how many $1000 items can you get a $50 discount on, compared to surfing around online?
david 10.22.13 at 1:44 pm
don’t forget the pleasure one gets in not having to worry about money — people get happy from being able to say “ah, fuck it, it’s only 50 bucks.” Maybe that works best when the 50 bucks is a smaller percentage of the whole.
otpup 10.22.13 at 3:08 pm
JQ, good point.
Then there is the issue of deceptive pricing (anybody rent a car recently). If you are talking about a 50% reduction in price, the likeliehood that margin of saving is real (i.e., most of it will translate onto the sales receipt) is greater.
otpup 10.22.13 at 3:10 pm
PS. JQ, I do hope you’ll post if you find anything interesting later in the book.
chris 10.22.13 at 3:12 pm
a meal is the sort of good whose quality is easy to judge
This may be a bit of a sidetrack, but if that were true, we wouldn’t have an obesity epidemic, would we? Some aspects of the quality of a meal are readily apparent, but others are well buried, and the tension between the two causes serious long-term health problems for a great many people.
Anarcissie 10.22.13 at 3:29 pm
Exerting price-consciousness helps keep prices down for other people, so it’s not only individually but socially beneficial and could be seen as having an altruistic edge to it.
I first appreciated this when I worked in a supermarket in the Bronx. There was a class of tough, mostly elderly immigrant women who concerned themselves with mere pennies on every item. They formed no more than ten or twenty percent of the customer population, but the manager of the store took care to observe prices at other stores and keep his own no higher. This was, of course, long before the Whole Foods era. Since then I have practiced my own natural miserly qualities with the conviction that I am doing general good.
TM 10.22.13 at 5:06 pm
This doesn’t really require much explaining. People do not act like rational economic agents. We have known that for a long time. There’s no need to look for a rationalization of these behaviors. They just aren’t based on economic rationality. A lot of the time, I would hypothesize, perceived justice is a much stronger motivator. Paying $100 for an item that should only be $50 isn’t just money wasted, it’s also insulting and makes me feel cheated. That is not the case when the discrepancy is only 5%. Many of us waste a lot of time and money trying to right a perceived injustice, from calling the phone company about a minor but still outrageous billing error to lawsuits that only ever benefit the lawyers. Many of these actions are not rational. I could go further and point to wars being fought over ancient injuries. Humans do not in general behave rationally in terms of furthering their self-interest, and any theory based on the assumption that they do is doomed to failure.
Paul J. Reber 10.22.13 at 5:30 pm
For the $1000 item, there’s a missing element of the transaction cost that I think is important here — at least it would be to me. For anything I can imagine buying for $1000 or more, I would spend some time considering the seller. Is the item going to work as advertised? Will a warranty or guarantee be honored? Will I have the option to return it if desired?
Those are important considerations for more expensive buying that I would attempt to judge based on the quality of my interactions with the seller at purchase. I can’t say I’m an expert at this, but an accommodating salesperson with a good shop that appears to have been around for awhile with happy customers seems like a good thing. Having made the decision that I have confidence in the seller (at $1050), driving across town to save $50 on the price does not guarantee it’ll be a better deal when I get there.
I don’t think you can do very useful behavioral economics if you make too many simplifying assumptions — like only price matters. I’m sure people make plenty of non-rational decisions, but I also suspect a lot of apparent non-rationality is simply a consequence of a poor model that leaves out important factors in decision making.
Chris M 10.22.13 at 6:53 pm
Also if you consistently using a percentage-based heuristics beats consistently using a difference-based heuristics over the long-term, then it is relatively better to use a percentage-based heuristic.
Anderson 10.22.13 at 9:09 pm
The post is premised on Quiggin’s seldom buying anything in the $1000 range – doesn’t hurt his argument, but wouldn’t obtain for everyone.
Random Lurker 10.22.13 at 9:53 pm
It seems to me that the most likely explanation (also the most realistic in terms of my personal experience) is that people do not experience numbers mathemathically, but instead think in terms of categories of quantity of different size.
For example, from 5 to 15 is small, from 16 to 50 is medium, from 50 to 100 is big, from 101 to 500 is very big, from 501 to 3 000 is “important purchase”, from 3 001 to 20 000 is “very important”, from 20 000 to 100 000 is dramatic.
A change in price on a small number is more likely to trigger a category jump, so is perceived, whereas the same change on a big number is simply not perceived (the item that costs 1 050 costs “the same” of the item that costs 1 000).
Incidentially, when you think that calculations also have a price (in terms of fatigue) this is most likely a very efficient way to gauge prices.
More generally, something is to say that people are somehow “rational”, and somthing much different is to say that people are ultraefficient computers that can gauge the “utility” up to the last cent.
bxg 10.22.13 at 10:27 pm
@ Chris M: Also if you consistently using a percentage-based heuristics beats consistently using a difference-based heuristics over the long-term, then it is relatively better to use a percentage-based heuristic.
This seems to me to be a clever possible answer, and in fact a very satisfying one indeed if true. But when I think more critically I’m having trouble connecting the dots: why exactly would a percentage basis heuristic be better (either in the outcome value, or in simplicity and applicability) than an absolute difference heuristic? The latter is no more complex (or is it?) and seems to give better outcomes in the long-term (again, ?).
John Quiggin 10.22.13 at 11:19 pm
To spell it out, suppose a Zipf’s law distribution of purchases, with about 10 times as many $100 items as $1000. Then, if a once-off effort can save $x on either kind of purchase, the return is 10 times as high for the effort allocated to $100 items compared to the effort allocated to $1000 items (so, proportional heuristic works)
On the other hand, for unique purchases, at any price, all that matters is the comparison between the $x saved and the effort needed (hence, absolute difference heuristic)
bxg 10.23.13 at 1:05 am
> To spell it out, suppose a Zipf’s law distribution of purchases, with about 10 times as many $100 items as $1000. Then, if a once-off effort can save $x on either kind of purchase, the return is 10 times as high for the effort allocated to $100 items compared to the effort allocated to $1000 items (so, proportional heuristic works)
If this is an answer to me, let me confess to still being lost.
In terms of your original question, where is the “once-off effort”? Unless one imagines buying 10 of the $100 item for $50 all at once, amortizing the driving cost [and surely you aren’t thinking this, this would trivialize your own question], it isn’t a question of a once-off effort helping me with all items in that price range forever. I save $50 each purchase, not matter what the total cost, and need to trade it against the
driving cost.
If (I’m not sure) you are proposing a cognitive error – something like: we attribute
the driving cost for one $100 purchase to all other purchases of that nature even if we need to drive separately to them all – but if so I repeat the question: why do we make this cognitive error? Any answer in terms of simplicity or ease would be satisfying, but why is it _simpler_ than looking at the absolute gain on each decision?
Richard Coppola 10.23.13 at 1:20 am
Your analysis is an economic version of time saving, e.g. http://xkcd.com/1205/
John Quiggin 10.23.13 at 6:01 am
@24 Exactly right, including the mouseover
bad Jim 10.23.13 at 7:56 am
Contrary to the point I argued initially, Trader Joe’s has made it difficult for me to buy wine anywhere else, because whenever another store carries the same bottle it’s a bit more expensive. I remind myself in vain that it’s only a couple of dollars, and wind up with a mass produced Bourdeaux just because it’s only one dollar more than I’d otherwise pay.
Trader Joe 10.23.13 at 11:20 am
@26
Sorry about that bad Jim, but please enjoy the wine ; )
Two-buck Chuck (now three buck) is designed to defy all utility calculations.
AJ 10.24.13 at 3:04 pm
> Any answer in terms of simplicity or ease would be satisfying, but why is
> it _simpler_ than looking at the absolute gain on each decision?
Because people often use various heuristics to make decisions. Anchoring is a powerful effect, and marketers exploit it. They may make the $50 off thing sound like something not worth pursuing. This applies to even executives. Again, executives are notorious for being analytically challenged.
> On the other hand if the item costs $1050 and could be had for $1000, people
> with reasonably high incomes mostly pay up, instead of driving to the other store.
There are two types of people in the world – the FatWallet/Thanksgiving Friday type and the other kind. I actually never fall for this decision making boo-boo. I know many people who don’t also. It may have to do with being a poor graduate student once. If anything, I try to squeeze for bigger discounts, the more opportunity there is.
This seems to be a standard staple of behavioral economics literature, however. I recall Daniel Gilbert talking about this once in one of his talks. Max Bazerman is also all over it as well. The instant Max mentioned it – I remember thinking that this is exactly the problem with the average person’s decision making models. They don’t think like engineers.
If you are a good decision maker, you would know that the key is to squeeze hard on the big money decisions. e.g, buying a house, buying a car, et cetera. If you do that, you can afford to be less careful about the small decisions and thereby save on the overhead of frequent decision making.
The most surprising thing for me is that people who are coming straight from India and China these days are already armed with smart phones and inexpensive phone plans (family plans via relatives, FTW!) and make sure that they don’t fall into exactly this decision trap. One guy I know is a waiter but is doing a degree in computer engineering at a local college. He seemed exactly the type of guy who wouldn’t make this mistake. I gave him some tips on family plans with relatives (for cell phones) and he caught on immediately. If you have ever lived on $600 dollars a month with $300 going for rent, this stuff is, like, simply basic.
dax 10.25.13 at 12:26 pm
If you’re talking about capital goods, it makes perfect sense to prefer to save 50 Usd on good A costing 100 Usd rather on good B costing 1000 Usd, especially if the sale on good A is exceptional.
The value of a good isn’t the price you pay for it, but somewhere between the price you pay for it and the price you can sell it for. Suppose we use the mid price. And suppose the value you can sell a good is 80% of its usual selling price. (Obviously, you won’t be able to sell Good A for 80 while the sale is going on, that’s why you need to suppose it’s temporary.) Then the value of a good (its mid) is 90% of its usual selling price. So the value of Good A is 90 but you’ve paid 50 – a good buy. While the value of Good B is 900 but you’ve paid 950 – a bad buy. In the case of good A you’ve increased you total wealth while in good B you’ve decreased it.
AJ 10.26.13 at 12:17 am
Fool me once, shame on you.. me.. you. Fool me twice, … you can’t fool me a second time.
> If you’re talking about capital goods, it makes perfect sense to prefer to save 50
> Usd on good A costing 100 Usd rather on good B costing 1000 Usd
This is true. The problem is that people do this even when the experiment is running using lotteries where you will win exact dollar amounts. We are not talking about products here. We are talking about actual cash.
The problem is that this branch of study called behavioral economics studies why people make stupid mistakes. This part of the overall research project that shows how “smart people” (it is often experiments run on hapless MBAs) make certain specific types of mistakes in such scenarios as the newsvendor problem where a precise, clear-cut analytical solution exists.
The solution to the puzzle is pretty simple- drop the assumption that these executive guys are smart. Instead, adopt the following hypothesis (H1): assume that the exective chappies are no smarter than George W. Bush. Then, you have a much simpler, one that fits the facts quite well- these bozos simply don’t have the brains to make complex decisions.
Hypothesis H1 by itself explains a lot:
a. why America went to war in Iraq (this is owing to idiotic decision making by Harvard MBA George W. Bush).
b. America’s screwed up response to Hurricane Katrine (this is owing to idiotic decision making by Harvard MBA George W. Bush).
c. the decline of America in the aughties (this is owing to idiotic decision making by Harvard MBA George W. Bush)
The sooner we realize we are not living in Plato’s Republic, one run by smart philosopher-kings, the better off we will be.
AJ 10.26.13 at 12:18 am
Apologies for the typos.
AJ 10.26.13 at 12:48 am
Aha! So I won that round, I think.
I have a simple sociological theory (S1) that explains the rise of “Nudge”-onomics. Here it is my little attempt at a Copernican Revolution in the field :
S1 – it is not in the interests of economics faculty to move away from the “Nudge”onomics school of thought. Professors have no incentive to publish negative results. So they don’t.
Take Max Bazerman. He can’t very well say that Harvard MBAs don’t have the necessary brain power to engage in the type of decision making they are supposed to be engaging in – as management consultants, as managers, et cetera. Hence, these guys come up with this “Nudge”-onomics thing, whose basic premise, roughly, is this: ‘It is not that people are being idiots. They simply haven’t been nudged in the right direction.” Same for Sendhil Mullainathan and his “Nudge”y theories. All these Harvard undergrads go on to become management consultants and managers. Sendhil can’t very well say that these undergrads are, in fact, incapable of doing their jobs. “Nudge”-onomics, therefore, is employed for this. It is a vile thing to do but I do know that business school professors are perfectly capable of being vile. Trust you me.
The main critique to the “Nudge”-onomics school of thought? Wait for this. Okay, here it is- you can nudge people one time. You can nudge people a second time. But it is not going to lead to any long term change in behavior. Surprise? Not to me, at least.
The current situation in business school deparments seems, as far as I could tell, to be that they are looking for faculty who can’t do calculus (an Operations Management professor at HBS, Ryan Buell, can’t even do calculus, which is more or less the foundation of the field). This means that a lot of these theories to these poor dears sounds correct – and true.
This whole situation reminds me of the Los Alamos project, where, IIRC, they only wanted janitors who couldn’t read.
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