Logic is in the Eye of the Beholder

From an interview with psychologist Daniel Kahneman, the first psychologist to win the Nobel prize in economics. --

A shopper, for example, might drive across town to buy a $10 calculator instead of a $15 one, but forgo the same trip to purchase a $125 jacket for $5 less, illogically believing the greater percentage saved on the calculator makes the trip more worthwhile.

Is paying attention to percentages really illogical?

What if we substitute goods? Instead of the $10/$15 calculator, substitute a bottle of $10/$15 wine. Instead of a $120/$125 jacket, substitute a $115/$120 carton of 8 bottles of the same wine.

Share this

Now I see where the

Now I see where the discrepancy in assumptions is. You are assuming that both the calculator and the coat are going to be bought today and the only question is where and at what price they are to be purchased. You are not allowing for any uncertainty.

Yes, that's right. The assumption is that the individual has decided that buying the item right now is worthwhile at its current price. The only decision is whether it is worth putting in extra effort to get a lower price. The question of whether the item will be available even more cheaply later is a whole different topic.

The problem with that is

The problem with that is that the percentage off *does* matter quite a bit.

Your "personal demand schedule" for calculators is likely to be different than it is for a $125 jacket. 33% off of the price is, relatively speaking, going to have a greater effect than a 4% decrease in the price of jackets.

Even from a standard neoclassical micro standpoint, its logical to realize that $5 absolute savings is better for the calculator than for the jacket.

And that's not even taking into account people's different marginal utility of cash- you're all jumping on the $5 absolute value while ignoring the HUGE absolute difference between the jacket and the calculator...

I find it a little hard to

I find it a little hard to believe that anyone would be indifferent between buying a carton of 8 wine bottles for $115 or buying 8 separate bottles for $80.

If I have a limited discretionary monthly income, say $200, the bang for the $200 bucks I get will be larger if I preferentially look for larger percentage bargains in the things that I purchase.

The value of money is derived from the demand to hold it to fund purchases in an uncertain future. If the future were not uncertain, then there would be effectively no demand to hold money as it could be spent immediately for discounted known future purchases or it could be invested at interest, with the return of both principal and interest at the instant in which it is needed. The uncertainty of the future includes both variations in the prices that goods may become available for and variations in the subjective value that a given good may acquire for a given individual. In any case, part of an economising in the use of money by an individual includes looking for high percentage discount bargains.

Regards, Don

Perhaps the relevant

Perhaps the relevant standard is a person's disposable income rather than their total wealth.

And what about opportunity costs? If I wait a bit on the jacket a sale could materialize that would save me $20 or maybe $50. That will never happen with the calculator.

Patri, The standard

Patri,

The standard viewpoint says that five bucks is five bucks. Running across town to save money is viewed as an income-earning activity. To decide whether to do it, you compare the gains (dollars saved) with the cost (time used). Then you decide if you want to earn income at that rate. It doesn’t matter what you are saving money on.

Now I see where the discrepancy in assumptions is. You are assuming that both the calculator and the coat are going to be bought today and the only question is where and at what price they are to be purchased. You are not allowing for any uncertainty.

I (we) am/(are) assuming that the actual purchase and/or its timing are open to question as well. Given that uncertainty DOES exist, the logical strategy is to make opportunistic purchases as bargains become available, balancing the subjective time preference for the given good with a judgment of future discounts possible and remaining available funds.

Regards, Don

right all around. The

right all around.

The problem is that the demand curves are different for the various items. I would definitely walk a mile to get $5 off a pack of cigarettes, but not to get $5 off a house.

I can forgo the house very easily, but not so much the cigarettes.

Sean, There is yet another

Sean,

There is yet another angle, and that is: what is the cost of the bargain? Think of that $5 savings as a commodity (paying for money: the same way that you "pay" for interest on an investment). In the calculator/jacket example, the "bargain commodities" being sought are identical, $5.

However, the relative monetary investment that one must make in order to attain that commodity is very different ($15 vs. $120). So, then, it boils down to the externalities of need and value of the primary commodities.

Even from a standard

Even from a standard neoclassical micro standpoint, its logical to realize that $5 absolute savings is better for the calculator than for the jacket.

Brian - this is not true at all! The standard viewpoint says that five bucks is five bucks. Running across town to save money is viewed as an income-earning activity. To decide whether to do it, you compare the gains (dollars saved) with the cost (time used). Then you decide if you want to earn income at that rate. It doesn't matter what you are saving money on.

Now, this is not how people actually think. But that's the standard view - I am quite sure of that.

And thats not even taking into account peoples different marginal utility of cash- youre all jumping on the $5 absolute value while ignoring the HUGE absolute difference between the jacket and the calculator…

There is of course different marginal utility for cash. If I only have $1,000 and no expected future wages, then there is a big difference between saving $5 on a $10 item and saving $5 on a $1,000 item. But the standard assumption in analyzing micro decisions is that the cost of the item is small compared to the person's total wealth.

Yes, percentages are

Yes, percentages are illogical when you are comparing identical goods. The value of your time is measured in dollars per hour, not in percentages. If you focus on percentages, you get the nonsensical idea that you should be equally willing to save 10% on a 1$ candy bar as a $100,000 house.

But of course we have to be talking about identical goods. Percentages are relevant when comparing different goods. ie the difference between two versions of the same good (houses, calculators, whatever) is likely to be substantial if the percentages are substantial. A calculator that costs twice as much will probably be a lot better, same for a house, same for a jacket...

Patri, The question here is

Patri,

The question here is in terms of a $5 discount sale off of goods with various list prices. Non-identical goods with different list prices and no discounts can be shown to be equivalent for the information provided, but would be a distraction here.

Is it really logical to be indifferent to the list prices of the goods, and the percentages, that a $5 discount is applied to?

Regards, Don

I'll note that if you're

I'll note that if you're going to buy both you should be indifferent to which one you have to cross town to buy.

I think that the point is

I think that the point is that the trip across town saves/makes you exactly the same amount in all cases - $5. The actual produce you're purchasing or the relationship between $5 and the price you're paying for the product is irrelevant, logically.

I'm not quite sure why a

I'm not quite sure why a purchaser has to be a rational actor to begin with. :behead:

[quote]Now I see where the

[quote]Now I see where the discrepancy in assumptions is. You are assuming that both the calculator and the coat are going to be bought today and the only question is where and at what price they are to be purchased. You are not allowing for any uncertainty.[/quote]

Isn't that the point of a thought experiment? Hold all other things constant while assuming that the only difference is in the single variable whose effect you're testing?

The marginal value of $5 to me should based on how much money I have and my income, not on what I happen to be purchasing at that moment. To base it on what I'm purchasing would be illogical. Of course, it's entirely subjective, but at the end of the day, the guy who drove across town for the $120 jacket is going to have the exact same amount of extra money due to that drive as the person who drove across town for the $10 calculator. Clearly someone who has more money is going to care less about the drive across town, but I seriously doubt the writer was making the claim that everyone should give money the same marginal value as everyone else.