The value of a discount
What is the last item you bought? Maybe a coffee, a pack of bin bags during your weekly shop, or a vacuum cleaner. What was it worth to you?
That is a question which is hard, if not impossible to answer. But one thing we can fairly safely assume is that its value in your eyes was at least the amount you paid for it. Otherwise you would simply not have bought it, would you?
When traders buy goods for a certain price, they are not interested in keeping these items. To them, the so-called surplus is entirely represented by the margin they expect to make when they come to resell the items. But end users like you and me are not intending to sell on our coffee, our bin bags or our vacuum cleaner at a profit. To us it is not the direct economic value, but other aspects of what we buy that represent our surplus.
What the price tells us
If — as is sometimes the case — we don’t buy the cheapest item in a particular category, there has to be some extra utility about the item we acquire that justifies the higher price. The enhanced enjoyment of a shot of flavoured syrup in your latte might outweigh the extra cost, for example. Maybe we’ve had a bad experience with a bin bag tearing, and the more expensive, branded variant has turned out to be a bit more robust. And perhaps the vacuum cleaner carried a best buy label from the consumer organization, which gives us some confidence that a higher price means that it performs better or will not break down one day after the warranty expires.
The economic term utility, however, suggests a utilitarian approach that is not always accurate. Perhaps we just believe that the branded bin bags are better, because they are more expensive (this is known as the price-quality heuristic). The economist Oswald Knauth, in an article published as long ago as 1949, describes a retailer who, after a few weeks of lacklustre sales of stockings priced at $1.00 per pair, decided to raise the price by 14% — to an “enormous response”. The explanation was that a higher price was strongly suggestive of better quality