Tag Archives: utility

06.11.2012 | Was That Birthday Card Really Free?

Have you ever been delighted that you got something for free? I was until I read “the cost of zero cost” in Dan Ariely’s book, Predictably Irrational.

My story begins at a Papyrus store in NYC. About to pay for several birthday cards, the salesperson told me I would get one free if I just added another card to my purchase. Unfortunately, I did. I spent another 5 minutes that I could have used elsewhere to choose 2 cards that I did not need.

To explain our emotional response to “free,” Ariely asks the reader to quickly decide between a $10 Amazon gift certificate or a $20 Amazon gift certificate for which you pay $7. Most people in his experiment at a Boston mall selected the “Free” option. But, as you probably realize, the second one is better.

We can’t leave this discussion about “free” without a look at “free shipping.” Do you remember when Amazon told customers they would get free shipping on all orders above a certain amount? Like me, you might have bought 2 books instead of one to get the deal. In France, at the same time, Amazon charged the equivalent of 20 cents-a miniscule amount- for shipping and received no extra orders. Then, when they eliminated the charge, French orders climbed.

Ariely does not mention, though what happens when everyone offers free shipping. Do we perceive it as free anymore? He does say though, that free is a great incentive when government wants us to buy electric cars. Just give free inspections or registration. Preventive health care? Just make it free.

But, is it really free?

Maybe my greeting card was cheaper but the extra time I spent, the 2 unused cards still sitting in my drawer, and the money I could have saved or spent elsewhere made that “free” card rather expensive. I guess our bottom line is, “There is no such thing as a free lunch.”

Here is an excellent discussion of Ariely’s book in the New Yorker.

Posted by: adminEcon
Tags: cost/benefit analysis, Dan Ariely, free lunch, free shipping, opportunity cost, TANSTAFL, utility
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03.06.2012 | Everyone Hates Free Parking

By Mira Korber, guest blogger.

Last Friday evening, two unexpected things happened at the highly attended Palm Beach International Equestrian Center (PBIEC) “Nations Cup” event.

1. I saw Donald Trump in the flesh — he’s very tall – from about two feet away.

2. I noticed an unusual parking situation. The “free” lot held 12 cars. The $20 parking fee lot housed (from my best guess) between 1,000 and 1,500 vehicles.

I would have expected the free lot to be full; a shiny complimentary shuttle bus carted me to the event and back while paying customers eked in and out of full “lots” (riding arenas at the showgrounds) at a painfully slow rate. In fact, my sleek “free parking” shuttle bus followed Donald Trump’s top of the line Mercedes right out of the horseshow.

Why weren’t more people on that “free” shuttle efficiently following Mr. Trump off the premises?

“Free parking,” on principle, sounds “worse” than parking you have to pay for. The old maxim, “You get what you pay for” seems to have caused the sparsely-populated free lot. Demand was higher for a more expensive service because the consumer automatically expected it to be better.

This fascinating paper from Wharton School of Business (“When Do Higher Prices Increase Demand? The Dual Role of Price in Consumers’ Value Judgments”) explains the idea with case studies and experiments. Though the paper states that “an unequivocal positive relationship between price and perceived quality is yet to emerge,” it cites some situations that reflect the scenario where high price leads to high demand.

A parallel to my parking story emerges with the following case study (pg. 3): a $79 piece of technology called the Minivac 601 gained a strong customer base in schools and home users. Large corporations, however, dissed the product. But when Minivac 601 became Minivac 6010, and its price went up to $479, suddenly the product had purchasing appeal to large companies. The new, expensive Minivac was simply a different color and slightly modified design, but nothing more.

For some people, free parking costs too much.

The Economic Lesson

Demand reflects decision-making. In the case of parking at PBIEC, I witnessed a greater demand for paid parking than free parking. Attendees determined that paid parking had a greater utility because it validated their status as wealthy spectators.

While one might expect the demand curve for free parking to be horizontal and almost infinitely long, it turned out to be shorter than the paid parking curve because it offered lower utility (status) to consumers.

While this doesn’t really make a lot of sense, it turns out our human behavior doesn’t follow rational economic theories. Daniel Kahneman, 2002 winner of the Nobel Prize, explains our irrationality, quite rationally.

An Economic Question: Have you ever dismissed something as “too cheap” to be any good?

Posted by: adminEcon
Tags: behavioral economics, car parking, demand for parking, donald trump, free parking, free parking psychology, kahneman, parking, parking economics, parking lot economics, rationality theory in economics, utility
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08.03.2011 | Supply, Demand and Internet Dating

What if, “you’re an 8 constantly chasing after 10s and constantly being chased by 6s?” Described in the Financial Times, the developers of Match.com’s algorithm, codenamed Synapse, have an answer.

“It’s just supply and demand.”

On the supply side, we can find individuals with certain characteristics–maybe age range, hair color, body type, religion–who are available for a relationship. Similarly, on the demand side of the market are men and women who, seeking a mate, will be more likely to respond when the supply side has the characteristics they seek.

Equilibrium? Where the attributes from the supply side are equal to those on the demand side. And therein lies the problem for our person who is an “8.” He or she will be a part of clearing the market when satisfied with another “8.”

The Economic Lesson

Nobel prize winning economist Gary Becker tells us that marriage is about a lot more than love. Instead, we can best understand marriage by looking at utility functions and marriage markets.

People marry because they expect to, “raise their utility level above what it would be were they to remain single.” (The Essence of Becker, p. 273) Looking for their best mate, they compete in marriage markets that have demand and supply curves. To see Dr. Becker’s descriptive and quantitative explanations, you might want to look at The Essence of Becker, pp. 273-328.

An Economic Question: What marginal utility might marriage provide to newlyweds?

Posted by: adminEcon
Tags: demand, Gary Becker, internet dating, love, marriage, Match.com, supply, utility
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04.06.2011 | PC Benefits

We know that the computer has really made a difference. It replaced typewriters, photo albums, calculators and maybe even travel agents. But still, can we precisely state its impact?

Yes, $1700.

Economists have calculated that each year since 1977, on average, computers have added $1700 of benefit, or “welfare gain,” to our lives “above and beyond what we paid from them.”

Electricity also created a huge welfare gain. By contrast, the benefit of Apple-Cinnamon Cheerios was tiny (yes, they really were studied). Looking back at the 17th century, one researcher explored the welfare gain of introducing coffee, sugar, tea and tobacco to the European diet.

Austin Goolsbee, a top economic advisor to President Obama, co-authored a study of the welfare gain from the internet. Because the monthly payment that covers most internet service is unrelated to quantity, Dr. Goolsbee and his associates concluded that they could not use dollars to determine cost. Instead, they looked at the opportunity cost of the time spent online.

The Economic Lesson

The benefit we derive from computers could be called our welfare gain. One way to calculate welfare gain is to subtract the actual dollar cost of something from its usefulness, or, as an economist would say, its “utility.” (If you want to see how utility becomes a concrete equation, you can look here.)

To calculate the welfare gain from computers, researchers originally focused on two areas during a 27-year period, 1977-2004. 1) The dollar cost of that computing capacity; 2) The utility of that computing capacity. Why did they start with 1977? Because the first mass-produced computer, the Apple II, was introduced then.

Having said all of this about welfare gain, the final question that comes to mind is why? Why do economists believe it is important to know about welfare gain? Maybe we can think about the statistics that might relate such as the CPI and GDP.

Posted by: adminEcon
Tags: computers, cost/benefit, CPI, opportunity cost, utility, welfare gain
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01.08.2011 | The Value of a Price Tag

Asking, “Do More Expensive Wines Taste Better?” a group of researchers decided to find out. They described the results of their study in a working paper for the American Association of Wine Economists (AAWE).

The researchers introduced their paper by citing studies that concluded people expect a “positive correlation between price and quality.” They then explained that their experiment involved “blind tasting” of wines whose prices ranged from $1.65 to $150. The results? They differed between the non-experts and experts. For the non-experts, drinking unidentified wines, the less expensive wine was more frequently chosen as better. For experts, the opposite was true.

(While other studies from the AAWE include a paper on wine investing and carbon and the global wine trade, one title particularly captivated me: “Can People Distinguish Pate from Dog Food?“)

I recommend the Freakonomics podcast that described the wine tasting experiment.

The Economic Lesson

As economists, how might we describe the connection between a price tag and enjoyment? We can refer to utility. If a higher price increases enjoyment then we can conclude that it also increases utility.

Posted by: adminEcon
Tags: American Association of Wine Economists, price, utility, wine
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