The Freakonomics blog provides another perplexing picture (the last one was discussed here). This time we have a situation where it costs LESS to buy two of something then to buy just 1. So they are PAYING people to take the second unit. What gives?
The way I see it, there are two likely explanations:
- Firms realise that, given buying two units is cheaper than buying one, everyone will buy two units. However, by pricing a single unit at such a high level they give people the impression that the good is worth more – fundamentally, in this case, the value associated with buying the good is related to its price.
- Individuals are time inconsistent. Realising that one way to prevent themselves being in a situation where they suffer from this inconsistency, they want to limit the amount of the product they buy. We discussed this with chippies a while back. If there are two sets of customers that value the good differently, and a time inconsistency problem, this could be a form of PRICE DISCRIMINATION between the two sets of consumers. In essence we could have one set of customers that values the commitment device strongly, and one that doesn’t!
In both cases we have to assume that there will be no resale – the search cost associated with finding a matching partner for resale is prohibitively high. However, given this assumption both explanations could work – people could determine there value of a good based on a related price, or it could be a form of discriminating between customers based on how heavily they view buying a small packet as a commitment device.
I prefer the second explanation, as we don’t have to make an additional assumption regarding what people value. I find the first explanation believable as well.
The main lesson I take from this is, market pricing is a crazy thing that is hard to understand – but it gets the job done. I doubt that we can effectively try to determine what the right prices are ourselves, when we can’t understand the mechanisms firms use to maximise their profit. So let the market do its thing, and use the government to solve identifiable market failures and co-ordination problems and redistribute.
I realise this is the lesson I take from everything …