Plus Shipping Costs

For Christmas I gave various different family members a calendar of my photos (ever to my surprise this always goes down well). To create my 2013 calendar I used Vistaprint. They are very good - all I have to do is upload the photos onto their website, choose the exact format I want and the delivery address. However, their pricing strategy is annoying.

The headline figure to print one calendar is £7.

I wanted 7, which cost about £4 per calendar. So far, so good. They encouraged me to buy in bulk.

The bad news...

These prices did not include shipping costs. Or VAT. But by the time I had discovered this, I had already invested too much time and effort on the Vistaprint website to bother going elsewhere. So I paid up the additional £20. Yes, £20.

Conclusion: Vistaprint cleverly induced me to use their product with a low headline price, but I finished the transaction in a bitter state of mind; reducing the likelihood that I would use Vistaprint again. Keeping customers can be hard when you follow the surcharge strategy.

BOGOF

We all like a good deal. Getting something for less than it should be is great feeling. And some deals are just too good to turn down.

So it is with good reason that retailers obsess about making us perceive their goods as a good deal. A myriad of 'special offers' and 'bargains' are out there, each one trying desperately to lure us into a different shop. Each one trying to make us think that it is an offer simply too good to refuse. I dread to think how many times we will read Buy One Get One Free! over the course of our lifetimes.

Another example is Boots which recently ran

Every Third Item Free!

For once, the small print was interesting. 

All the items you are buying are ranked in price order, high to low. Then every third item is free. So if you were buying three things, the cheapest would be free. If you were buying six things, the third most expensive and the cheapest item would be free. So it is a better deal than getting the two cheapest items free from six. 

But I'm not sure many people would bother to read the small print on an offer for toiletries. On more expensive products, such as electronic goods, I would expect consumers to spend time understanding small print. But not when it comes to low cost items such as shampoo and razor blades. 

In conclusion, Every Third Item Free! is a good eye catching offer, but it is also complicated. Simplicity was sacrificed.

Why Three Options?

I'm going to start with a confession: Over the course of my time as a student I have spent a lot of time in coffee shops. Starbucks. Costa. Nero. You name it, I've been there. One of the things which intrigues me about said coffee shops is that they tend to offer three different sizes of hot beverage. Small, Medium, Large. Tall, Grande, Venti. Primo, Medio, Massimo.

Why three?

 

Could it be that there are precisely three different types of people who buy coffee, each preferring their own exact drink size? 

Given that the actual sizes of mugs differ between the franchises, I think not.

Could it be that the manufacturers of mugs only do precisely three sizes?

Unlikely.

Or, could it be that coffee shops know some behavioural economics?

When offered three options we are likely to prefer the middle one. This is because we are risk-averse and regret-averse; we want to avoid being on an extreme. If offered two sizes of drink, we'll choose whichever one we like. If offered ten, we'll be overwhelmed by the choice. If offered three, we're likely to choose Medium; Grande; Medio.

Of course the thirsty will still go for the Large, and the thrifty for the Small. But by offering three options Starbucks, Costa and Nero maximise their revenue. They cater for all and simultaneously nudge people who would have bought Small into purchasing more coffee. 

So there you go: not all my time in coffee shops was wasted...

Corporate Charity

Last night on the walk back from the local I passed the premises of a local letting agency. Whilst gawping at the cost of renting a house in Nottingham I noticed something odd. The shop window had a large picture of a football team captioned with

Castle Estates are the proud sponsors of Pegasus YFC

Why did they sacrifice prominent advertising space for this?

We can but assume that Castle Estates reckon they'll earn greater profit by advertising their community work, rather than another property.

This would fit with a larger trend for businesses to conduct prominent 'good works'. Sainsbury's and Tesco both proudly sponsor charities. 'Corporate responsibility' is the name of the game. You do not have to be overly cynical to think that they are doing this to attract custom from approving consumers.

But why?

Why does it attract consumers to know that firms are giving some (probably minimal) amount of their profits to good works? As all profit comes from the pocket of the consumer anyway, surely this charity just means higher prices? Would it not be more efficient to shop somewhere uncharitable, thus paying less, and then give your savings to the charity of your choice?

If behavioural economics has shown one thing it is that people don't just care about simple monetary gain. We are complex beings with complex motives. We like to feel good and charitable as we buy our groceries, so Tesco sells us that feeling by giving to charity. Meanwhile Castle Estates proudly supports our community.

Know Your Wage?

I recently heard of a student who had started working part time at a cafe. Three weeks into the job she still did not know how much she was being paid (her first pay day had not yet come). My first thought was "How irrational!"

But then it occurred to me that it might not be as irrational as it first seems.

First, a definition: Your reservation wage is the lowest wage at which you would accept employment.

Now, a law: In the UK you have to be paid at least the minimum wage of £4.98 an hour (aged 18-20).

So, in theory if the student in question had a reservation wage of £4.98 or less, she would not care about what the cafe was paying her, because she knows it has be above her reservation wage by law.

So, she could be rational.

But then, another thought occurred to me: A rational worker would never have a reservation wage below the minimum wage. (Because they know that they could get paid more elsewhere - the lowest wage you would accept would never be lower than what you could get paid elsewhere). Thus a rational worker must have a minimum wage of at least £4.98 an hour.

Conclusion: Either the student has a reservation wage of exactly £4.98 an hour, or she is irrational.

Epilogue: This analysis assumes she is able to get a job elsewhere at the minimum wage. This analysis also assumes money to the only motivator for working. We assume her primary reason she is working is the wage, not the ambience of the cafe, for example.

Book Review: 23 Things They Don't Tell You About Capitalism

23 Things They Don't Tell You About Capitalism by Ha-Joon Chang of Cambridge University is a devastatingly insightful critique of free-market economics. Methodical, jargon-free and highly accessible, 23 Things takes apart the free-market paradigm, piece by piece. If you are a supporter of free-market economics, read this book, then get back to me. I freely admit that I am pre-disposed to many of Chang's arguments, but it would sow the seed of doubt in the mind of even the most hardened of right wing economists.

Most of the 23 Things are not about behavioural economics, but some of them touch on it. One of Chnag's conclusions is that:

"When we understand that the modern economy is populated by people with limited rationality and complex motives, who are organised in a complex way, combining markets, (public and private) bureaucracies and networks, we begin to see that our economy cannot be run according to free-market economics. When we more closely observe the more successful firms, governments and countries, we see thay are the ones that have this nuanced view of capitalism, not the simplistic free-market view." 

(p.250)

He proposes that:

"We should build our new economic system on the recognition that human rationality is severely limited."

and goes on:

"It is suggested we can prevent another major financial crisis by enhancing transparency. This is wrong. The fundamental problem is not our lack of information but our limited ability to process it." (p.254)

23 Things is notable for the abundance of suggestions for how to improve our lot. Chang never points out a flaw with the current system without suggesting an alternative. This makes for a powerful read. And a potentially uncomfortable one for free-market disciples. The following quote sums up his approach:

"Economics does not need to be useless or harmful. We just have to learn the right kinds of economics." 

(p.251)

If you are interested in how we shape our economy for a better future, then I cannot recommend 23 Things enough. 

I leave you with the thought that:

 "Market outcomes are not 'natural' phenomena. They can be changed." 

(p.257)

Genre: Economics
Accessibility: 9/10
Accuracy: 9/10
Readability: 7/10
Usefulness: 10/10
Verdict: Very, very interesting!

Remember Remember...

If we are rational creatures then we need to be able to remember accurately. Interestingly, however, our memory is as complex as a Rubik's cube in a maze.

One rule of thumb initially discovered by Daniel Kahneman is the peak-end rule. He got patients undergoing a painful operation to note down the amount of pain (out of ten) they were in, minute by minute. Thus he was able to create graphs of the sum total of pain patients experienced. For example (my data):

The patients were then asked after the operation to remember how much pain they went through. To be consistent they should have given the average amount of pain they recorded during the operation (here 5.5). But they didn't. Instead they tended to report the average of two points: the most memorable (the peak) and the end of the operation (here 5).

Thus our memory tricks us. We do not remember a how a whole experience (good or bad) was, instead averaging the best/worst bit and the end. This is a challenge to those who defend human rationality. If we do not remember accurately, then how can we make decisions that maximise our personal benefit/satisfaction/goals?

Kahneman then decided to prove the peak end rule (using, in my opinion, ethically dubious methods). He asked the surgeons to extend the operations subjects went through by leaving their instruments in the patient at the end for a couple of minutes. This increased the length of the operation. It also meant that the pain experienced in the final couple of minutes of the operation fell. In accordance with the theory, although the total amount of pain experienced went up, the amount of pain patients remembered fell. Gruesome but true.

Risky risky...

I am about to toss a fair coin. If heads you win £100. If tails you lose £100.

Do you want to play this gamble?

If yes, then you are risk-preferring.

If no, then you are risk-averse.

If you are indifferent, then you are risk-neutral.

That is because the expected value of the gamble is £0 (100x0.5 + -100x0.5 = 0).

Personally I would not like this gamble, which makes me risk averse. The extent of my risk averseness would have to be revealed by considering different gambles, but as long as I am consistent in my attitude to risk an economist could call me rational.

Here are a copuple of other interesting gambles which may shed light on your attitude to risk:

I am about to toss a fair coin. If heads you win £100. If tails you lose £75. Do you want to play?

I am about to toss a fair coin. If heads you win £1000. If tails you lose £50. Do you want to play?

If you would not like to play these gambles then you highly risk averse... Personally I think I would probably play both, definitely the latter one.

Russian Roulette

Scenario 1: There is a gun pointed at your head. It has six chambers. There are four bullets inside. The chambers will be spun randomly before the gun is fired once.

Scenario 2: There is a gun pointed at your head. It has six chambers. There is only one bullet inside. The chambers will be spun randomly before the gun is fired once.

In which scenario would you be willing to pay more to have one bullet removed from the chambers?

Interestingly, according to economic theory you should be willing to pay more to reduce the bullets from 4 to 3 than from 1 to 0. Is this the case for you?


For those who are economically inclined, here is a brief sketch of the proof of the theory:

Where u(.) is a von Neumann-Morgenstern utility function, p1 is what you are willing to pay in Scenario 1, p2 is what you are willing to pay in Scenario 2 and Y is your income.

In Scenario 2:

u(alive, Y - p2) = 1/6u(dead) + 5/6u(alive, Y)

In Scenario 1:

1/2u(dead) + 1/2u(alive, Y - p1) = 2/3u(dead) + 1/3u(alive, Y)

Re-write Scenario 1:

u(alive, Y - p1) = 2/6u(dead) + 2/3u(alive, Y)

Comparing scenarios:

u(alive, Y - p2) > u(alive, Y - p1)

Therefore:

p1 > p2

QED

Weight In Gold

Much thanks to Pete Everson for this nugget:

Gold is priced £32,845.67 per kg.

The average professional footballer weighs 73.5kg.

So that means that any footballer earning £2,414,156.75 a year, or £46,426.09 a week is being paid their weight in gold.

Some of professional footballers get paid multiples of their weight in gold!

Meanwhile the average annual salary in the UK is £26,500, less than one kilogram of gold.

Does this strike you as fair?

If you are concerned about fairness then you run this risk of being considered irrational by economists...