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The (high) price is right

Why it sometimes makes sense to pay more for a smaller sandwich

Would you pay more for two apples than for three? Not very likely. Doing so would go against some pretty deep-rooted assumptions. When we’re buying something, we are guided by a strong heuristic: if you require more of a certain good or service, the total price will be higher; if you need less, then you’ll pay less.

That doesn’t stop retailers sometimes making this kind of crazy offer, where you actually pay a smaller amount when you get more. Marketing, like deities, moves in mysterious ways, and someone somewhere presumably has worked out that, in some bigger picture, it is actually advantageous to sell larger pots of mayonnaise for less than smaller pots.

The price of luxury

Would it be irrational for someone to actually buy the smaller pot and pay 50p more? On the face of it, for sure. Even if you know that you only need 600g, and that some of the excess 200g will probably go off before you can consume it all, you would still seem to be better off buying the large jar, and simply throwing away the remainder on the eat by date. But perhaps the big container doesn’t quite fit in your fridge, or perhaps you don’t have spoons long enough to get to the bottom of the jar — there are any number of reasons why someone might find an 800g pot of mayonnaise simply too big.

What is unlikely is that anyone will buy the smaller pot of mayonnaise just because it is more expensive. In classical economics, when the price of a good rises, the demand drops, and vice versa. A lower price means the demand increases.

But there are goods that appear anomalous: demand for them increases when the price goes up, because being overpriced is actually a desirable characteristic. They are known as Veblen goods, named after the economist Thorstein Veblen. The main reason for their unusual behaviour is that their high price acts as a signal to the world: “Look at me! I can afford an expensive car, an overpriced handbag or an extravagant watch!”

One could generally buy several cars, handbags or a watches that are equivalent in all material respects for what you’d pay for one of these luxury goods. Preferring the latter is a clear case of paying more for less — if you overlook the perceived value of being overpriced. So the underlying logic here is pretty straightforward, and Veblen goods (and other positional goods) fit perfectly well in mainstream economics. Nothing irrational to see here. (It is rare for a product to be marketed openly and directly as pricey, but Stella Artois, a Belgian beer brand that is wholly ordinary at home managed it with the slogan “Reassuringly expensive”.)

Beyond signalling

Signalling wealth is not the only reason why people might prefer to pay more for less, though. This post was inspired by a tweet by Branko Milanovic in which he reports his strategy for limiting his food intake at lunch:

One reason why it might be important for a smaller sandwich not to be cheaper than a larger one is that it suppresses the temptation to buy an extra snack with the money saved, and end up eating even more. In a reaction, Merijn Knibbe took a slightly different angle: the higher price for the smaller sandwich reflects an additional element of value to the buyer. By choosing the smaller variant you can avoid the feelings of guilt provoked by eating the king size model. The consideration of pleasure and pain (or hedonic evaluation) drives a willingness to pay more to avoid something disagreeable, even if, objectively, it provides less material utility.

As so often when you’re attuned to a particular phenomenon, another instance of an unusual reason why one might be prepared to pay a high price for an item popped up soon after. After Apple decided to eliminate the headphone connector on its newest iPhones, it launched its own version of a set of wireless earphones at an eye watering price of $159. But someone quickly saw an upside to these pricey Airpods:

The majority of the replies suggest that not everyone agrees with this analysis. Yet the argument makes perfect sense. We are generally more careful with our more expensive possessions — precisely because they are more expensive. What better way to remind yourself constantly that you need to look properly after an object, than that it has cost you a fair packet?

High price bad, low price good?

Most of us are consumers most of the time, and so it is not surprising that, when we evaluate a transaction between a seller and a buyer, we tend to take the buyer’s perspective by default. A high price therefore appears to be ‘bad’ and a low price ‘good’. (There are interesting exceptions, for example the housing market, but that is a theme for another time.) The underlying idea is that buyers want to pay as little as possible, and sellers want to achieve the highest possible price — a high price should therefore mean that the buyer has got the upper hand in the transaction. That is very well possible. Even though a free trade is by definition a win-win transaction making both seller and buyer are better off, the actual price determines how the surplus is divided. If it’s low, the buyer wins more, if it’s high, it’s the seller who wins more. Unless you take sides (which a two-handed economist should of course never do), neither outcome is better than the other.

But as we’ve seen, there are obvious and less obvious situations in which a higher price may actually provide a clear benefit to the buyer as well. That is another reason why, in a free trade transaction, the price is always right, no matter how high it is.

Originally published at koenfucius.wordpress.com on September 15, 2016.

Accidental behavioural economist in search of wisdom. Uses insights from (behavioural) economics in organization development. On Twitter as @koenfucius

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