Thursday, September 20, 2012

Economic logic, Part I

The discipline of economics is founded on the idea that people are rational, at least to the extent that they will buy less of a good the more it costs.  But people are not always rational, of course (see, e.g., Dan Ariely's Predictably Irrational).

Some economists, such as Ariely, think our enduring irrationality is a blow against traditional economics.  I don't agree, but that is a topic for another entry.  What I'm interested in is some examples of apparently irrational purchasing behaviour that I have observed.

For example, I once heard someone discussing what toppings to put on a pizza.  "If I'm going to pay for extra toppings, I like to get meat so it's worth the money," he said.  At first, that seems to make sense:  all toppings typically cost the same, but meat is obviously more expensive than, e.g., mushrooms or onions.  But if you think about it, you're not trying to get the most expensive toppings for your money; you're trying to get the pizza you will enjoy the most for your money.  Imagine someone saying, "Green peppers are my favourite topping, but I want to get pepperoni because it costs more."  That doesn't make sense, but that is essentially the same logic the guy was using.

You might try to qualify this by saying that, other tastes being equal, you should prefer the meat topping, but that doesn't help.  What you are really saying is that you would rather the pizza place make less money from their sale to you even though it provides no benefit to you.  The only way this could make sense was if you were talking about a topping, such as lobster, which is so much more expensive than the other toppings that you rarely get to eat it.  But then what you're really saying is that lobster pizza has more value to you because you get it more rarely.  That's consistent with the basic principle of economics, which is that goods have a decreasing marginal value.  Even though in absolute terms you might prefer green pepper, lobster might have a higher value because you eat green peppers all the time and lobster almost never.

I have been subject to the "minimize profit" fallacy myself in one similar case.  I read that restaurants typically make little profit off of the most expensive items on their menus, because if they charged as much relative to the cheap items (such as vegetarian or chicken dishes) for fancy meats such as veal and lobster, no one would buy them.  For a while, I was caught in ordering the more expensive items because I thought I was getting a better "value" out of them, even though the extra cost rarely corresponded to extra enjoyment on my part.

No comments:

Post a Comment