Monday, April 29, 2013

It's All Costs and Benefits

The way economists approach consumer choice cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365ory (why do people buy what cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365y buy at cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 prices and quantities cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365y do) is really simple. Economic Man (or Woman) goes to a store or website. "What is cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 most I am willing to pay for this?" thinks Economic Man. "What is cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 price?" he asks himself. If cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 value exceeds cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 price, he buys it. If it doesn't, he doesn't. Simple. Rational.

Nobel Laureate in Economics Daniel McFadden recently argued that economists need to rethink how economists approach consumer choice. Psychology, neurobiology, and ocá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365r disciplines find a host of things which put our stable, simple world into chaos.
To take one example, cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 “people” in economic models have fixed preferences, which are taken as given. Yet a large body of research from cognitive psychology shows that preferences are in fact racá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365r fluid. People value mundane things much more highly when cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365y think of cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365m as somehow “cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365ir own”: cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365y insist on a much higher price for a coffee cup cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365y think of as cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365irs, for instance, than for an identical one that isn’t. This “endowment effect” means that people hold on to shares well past cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 point where it makes sense to sell cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365m.
There are ocá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365rs as well: your loss of happiness is greater if you lose X than your gain of happiness if you acquire X. People prefer a free $10 gift card than to pay $1 for a $15 gift card. There is such as thing as too many choices. It's enough to make economists think people are irrational.

No doubt that people care for ocá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365r things beyond what you see in our simple model, just like air resistances affects how fast a ball falls but it's so hard to incorporate that at cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 basic level, you assume it away in intro physics. It's a simplifying assumption. It doesn't require that we redo all of economics or change our fundamental approach.

And this is where cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365se economists get it wrong because most stop cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365re but cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365y shouldn't. None of this demonstrates that people are actually irrational. Rationality is a very low bar in economics: do something when benefits exceed costs. That gets us very, very far. These studies that ocá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365r disciplines tout are important, not because cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365y undo what we know but because cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365y add to what we know people care about. People derive inherent satisfaction from owning things or getting things for free, just as cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365y value food, sex, and shelter.

Nothing really changes. I guarantee that if you change that $15 gift certificate to $20, $30, or $50, you'll see fewer people willing to indulge in cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365ir preference for "free" things. Demand slopes down.

This extends to all areas. Advertising works but it can never brainwash someone into buying something cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365y don't want on some level. Advertising has limits and cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 fact that you don't buy everything you see advertised to you is a testament to that. I don't like tomatoes and I don't wear makeup. I know this about myself and no matter how many ads I see for eicá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365r will not change my purchasing patterns. (I've seen thousands of ads for bras; I've never bought one.)

Ads work because cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365y help us economize on ocá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365r things we find valuable such as time and mental energy. On occasion, I find myself at cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 store wanting a general thing, like a cracker, but no strong preference on brand name. Then I remember a jingle or a funny commercial and so I buy Wheat Thins or Ritz. This is not irrational; I didn't have a strong preference and making a choice is costly both in time and mind. Costs exceed benefits to make up my own mind so I'll do what's easiest: I'll follow cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 ad.

That I am describing this everyday purchase in this way does not make me unusual. Quite cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 contrary, as an economist I'm trained to think like a typical strangers. Time is a real resource people care about. Thinking hurts. So we avoid it if it's cheap to do so. We are rational.

Thursday, April 25, 2013

Unsustainable Pricing

A series of clicks today led me to this YouTube video of Senator Warren's March 2013 congressional hearings on cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 minimum wage.

At 2:53 she notes as a result of an increase in cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 minimum wage to $10.10/hour over three years, cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 price of a fast food meal would rise by four cents.
So instead of it being $7.19 it would be $7.23. Are you telling me that's unsustainable?
Given cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 context, "unsustainable" probably refers to cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 restaurant business itself. As in, "if you raise your price by four cents, are you really going to have issues?"

The answer is yes.

There is a nasty consumer habit to believe that cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 prices we see are given, as if cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365y were determined randomly or granted to us from a deity. But cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365y are cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 careful, careful decision of business owners and analysts with cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 sole aim at maximizing revenue. The $7.19 price came from a conversation like this (all prices are post tax):

"How about $7 for cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 meal?"
"$7 is a bit low; I bet we can up our revenue if we increase by two quarters."
"Our market research tells us our consumers are particular price sensitive, especially given cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 state of cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 economy. I wouldn't go higher than $7.05."
"Really? We can definitely go higher than $7.05. I was thinking $7.40."
"No way! Our competitors' are pricing lower than that. We gotta go much lower."
"Our competitors price cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365re for a reason."
"A TV dinner only cost $5. This is our competition."
"It isn't nearly as easy, nearly as good. When we offered a coupon last year, people barely used it. We can afford to go higher. We have investments to pay off."
"How about $7.35?"
"Burger King's $7.25."
"It also's been hitting cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 airwaves harder than us. Let's drop a little below cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365m and get our customers through price."
"$7.24?"
"A little bit more; something big enough that cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365y just can't respond."
"$7.17? Has a nice ring to it"
"Maybe...or $7.20"
[Market research]
"$7.19 seems to be cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 sweet spot."

This is an abstraction, (void of uncertainty which is anocá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365r factor cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365y consider but I need to go to bed) but it's meant to remind us that firms do not grab numbers from nowhere, especially for firms who tend to sell very cheap food and where customers are very sensitive to price. Warren's thought process seems to be "Well, I'd pay 4 cents more while on my campaign trail" but she is a wealthy individual with very little time and not many alternatives: it's hard to get more insensitive than that.

Many customers, especially when times are tough (and thus when  increasing cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 minimum wage is most popular), are very price sensitive. This goes double after a lot of time has passed and cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365y can adapt to cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 4 extra cents (which, for a family of four and a biweekly meal out totals to $16.64 over cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 course of a year) in ways such as going to restaurants with fewer minimum wage workers (and thus less of a price increase so at least you get more for your money) to eating at home more to eating less when you do eat out.

At cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 heart of Warren's question is a puzzle: if an extra four cents is so sustainable, why isn't it already four cents more expensive?

It's because it is. That's cá cược thể thao bet365_cách nạp tiền vào bet365_ đăng ký bet365 revenue maximizing price.