( credit: Ali Eminov CC BY)

Value, imagined

Is the value of stuff we buy, from grapefruit to airline seats, in the mind of the beholder?

Magic doesn’t really exist, but in a way, economics comes close. Contrary to what common wisdom maintains, there is something that is pretty much a free lunch: the miracle of trading. Just think about it: I’m going to the greengrocer’s to get my weekly ration of grapefruit, and come back with eight of them (they’re a little cheaper if you buy them four at a time), for just £2.80.

I think that’s tremendous value for money — I would certainly still buy them if they were, hmm… say 50p or even 70p a piece. While I am £2.80 poorer than before the transaction, instead I now have the fruit, which I think is worth more than the money I had to pay. At the same time, Mr Clarke is happy enough to discount his grapefruit from 39p to 35p if you buy them in fours, so we can presume he is, even at that price, still making money out of selling the golden orbs. We’re both winners in this transaction — isn’t that almost like magic?

Things can get a bit more complicated, though. Not all voluntary transactions feel as if they are a win for the buyer.

Imagine you visit a craft fair where you spot a stall with pottery, hand made by African tribeswomen. It is not at all expensive, especially bearing in mind that they are unique pieces, and of course your purchase will support the villagers. So you happily hand over £20 for a nice fruit bowl (suitable for grapefruit). But two days later you see someone else selling very similar handmade items at an ethnic market. One of the items on display looks remarkably like the bowl you bought earlier. At that moment, a customer walks up and buys that exact piece. As soon as she is gone, the seller ducks underneath the table, and produces an identical “unique” piece, putting it on the spot occupied by the one just sold not three minutes ago. You’ve been had. That evening, you go agoogle on the internet and discover that you’re not the only person who’s been taken for a ride: apparently there is a factory in the Far East, churning out this earthenware by the containerload, supplying dodgy vendors all over the world.

Sure, the seller has deceived you, and none of your money is benefiting an African village. But has anything materially changed to the fruit bowl you thought was so pretty before? No — it looks and feels exactly the same. It’s just your knowledge of it that is different. You would perhaps still have bought it, but while £20 felt like a bargain for a hand thrown fruit bowl, it’s way too much for one that came off a conveyor belt.

Which one is the real hand made one? (photo: Jonas de Carvalho CC BY)

Why, though? Somehow, we appear to believe that extra effort merits extra reward, as Dan Ariely illustrates with a by now almost classic anecdote about a locksmith. When he is inexperienced and takes a long time on a job, people praise his work, even if he does additional damage. But he gets criticized for his high fees when, thanks to his experience, can fix a lock in minutes and without breaking anything. We seem to value a lot of (inefficient) effort with a worse result more highly than a small amount of (efficient) effort with a better outcome.

There is something intriguing about this. A fruit bowl provides clear utility as a container for apples and grapefruit, and can provide additional utility by looking pretty. But why should the way it was produced matter to us? And when we’ve accidentally locked ourselves out, should the price we’d be prepared to pay to get back in depend on how that is achieved? (Arguably a locksmith taking a couple of minutes means we can be inside much more quickly — so why do we think that deserves less compensation than that of a bumbling novice taking an hour for the job?)

Effort is relevant, sometimes even dominant in how we value what we buy. If that effort is much less than we assume or feels appropriate, we conclude we have been robbed.

Unsurprisingly, most of us will experience a similar reluctance to pay for things that didn’t cost the provider anything. This suggests that our annoyance may be related to how we experience the concept of economic rent. This term refers to “excessive returns”, over and above what is necessary to cover the factors of production (such as capital, materials and labour). Its definition is open to some interpretation, but it chimes with the idea of “unearned”, and therefore undeserved income.

The airline industry forms a great example of charging passengers in different ways for pretty much the same thing. Part of what we pay for is the trip from A to B. But if you look at the cheapest economy ticket from London to New York (less than £300) and the dearest first class ticket (at least £3000), it’s obvious that there is more to it. Yes, first class seats are more luxurious, but that is hardly worth £2,700. (You could buy a very nice leather sofa, have a stupendous meal in a three-star restaurant and still have money left over.) They mostly represent status — something that exists, in effect, only in our minds, but that is very important for some. That must be why the people who fly first class generally don’t mind paying a big chunk of economic rent for something that doesn’t really cost the airline much.

No such thing as a free seat (image via Twitter)

Then there is the difference in price for an ordinary economy seat, and one with extra legroom. Arguably, the latter is costing the airline a bit more, as it takes up more space. The surcharge also ensures efficient allocation of a scarce resource: if you are very tall you can get the legroom you need.

But airlines go further still. There may be such a thing as a free lunch after all, but free seats is a different affair. Many companies now charge passengers for choosing a seat — not just one with extra legroom, but any seat, rather than being allocated a random seat. So if you want to sit next to your companion or your family members, pay up. This is getting close to pure rent seeking: the airline is not passing on a cost, but simply charges us because it can.

And if that was not enough, some airlines even limit the number of seats they are willing to allocate randomly for free, as Elspeth Kirkman, the head of the Behavioural Insights Team in the US, experienced. If you’re not quick enough, you’ll have to wait until you get to the airport to know where you’ll be sitting — unless you pay for the privilege.

Infuriating as fake handmade bowls, expensive locksmiths and rent-seeking airlines are, should we really be so bothered about the reasons and motives of a provider to set the price where they do? We can imagine value-enhancing elements (like being handmade), or value-reducing elements (like the short duration of a job), but they are after all just in our mind. We are annoyed at having to pay a tenner to reserve a seat, but would we be equally annoyed if the ticket was £10 more expensive to start with, and came with free seat selection?

If we had a genuine handmade bowl, and while we were not looking, someone replaced it with a machine made one, which looked and felt identical in all material aspects, so we would never notice the swap, would we really be worse off? Should we be concerned with the question whether it costs the airline anything to allow us to choose our seat in advance if we perceive that it has value?

Ultimately, only we can be the judge of that. It is not irrational to value pottery that is handmade by real people in a real African village more highly than materially totally identical pieces made by a factory in China. It is our mind that establishes what a bowl is worth — for its practical and esthetical utility, and anything else.

But it may well be useful occasionally to question our mind, and check how much we are really prepared to pay for value that is entirely in our imagination.

Originally published at koenfucius.wordpress.com on August 3, 2018.

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