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Monday, July 06, 2009

Irrational discounts

Imagine you are going shopping. (We all love that!)

This week, you are going to buy a new refrigerator (or something else equally big and expensive). You go to the appliance store and find a nice fridge which would be just lovely for your kitchen. You inquire about the price and learn that it is 10 000,- NOK for the unit. You are also told that if you wait until friday, there will be a sale and it will be reduced with 50 NOK, putting the price at 9 950,- NOK.

"Pah," you think, "It's only 50 kroner, that's not much," and you buy it today, not waiting until friday.

Later on, to celebrate your big purchase, you want to buy a new pair of shoes. At the shoe store you find a nice pair, and they are cheap too, costing only 200 kroner. The shoe store too is planning a sale on friday, you are told. On friday, the shoes will be reduced in price to 150 kroner. You think, "That's a good deal," and wait until Friday to buy your shoes.

Why is this? The savings would be the exact same total amount (50 kroner) but when applied to a very expensive item it does not feel as as big a discount as when applied to the shoes. Our brain thinks in percentages in that case. But in doing so it makes us irrational. If you are willing to wait until friday to save 50 kroner on some shoes, you should also be willing to wait until friday to save 50 kroner on a refrigerator. The net savings is the same.

But we don't. Remember the next time you get into that situation yourself: You are being irrational.

Update: Okay, irrational-ish. There are some exceptions and caveats which was kindly mentioned in the comments.

5 comments:

  1. Actually, that is not as irrational as it may seem. Think about it this way: Compare saving 50,- every time you buy something expensive with saving 50,- every time you buy something cheap. In the latter case you will save much more money in the long run.

    Also it is the aspect of paying 50 extra for getting it now. It may have a higher value for you getting that big shiny expensive thing now than getting just another pair of shoes now. It might even be worth so much for you that you will pay the 50 extra to get it right away, even though you know you will be back a couple of days later.

    You usually write very interesting posts, but this time I'm afraid you're wrong. :)

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  2. Well, yes. Adding the 'Getting it now' aspect can turn it from irrational to rational. I should perhaps have mentioned that, as there is definitely a value in getting something earlier. Still, if there were no rush in either purchase...

    And regarding the frequency... I buy new shoes about as often as I buy refrigerators. So saving more in the long run does not apply either :) (It still should not matter the price of what you are purchasing. A refrigerator becomes just another datapoint on the 'Saved money / did not save money' graph.

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  3. Don't think of it as refridgerator vs. shoes. Think of it as 10000,- items vs 200,- items. I think you will find you buy the latter much more often than you buy the former.

    What you are doing is seeing the actions as isolated events. While I am seeing them as connected events. You say each waste of 50,- is just as bad. I say wasting 50,- each time you buy something really expensive is better than wasting 50,- each time you're buying something cheap.

    You can compare to having a beer for dinner. It's not healthy for you. Do you find it more irrational during the weekend or during the week days? Isolated, it doesn't matter when you drink the beer. Each beer is just as unhealthy. But as a habit of actions it's better restricting the beer drinking to the weekends.

    Far from a perfect analogy, but it should show that it is more to this than just the isolated event itself.

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  4. "What you are doing is seeing the actions as isolated events. While I am seeing them as connected events. You say each waste of 50,- is just as bad. I say wasting 50,- each time you buy something really expensive is better than wasting 50,- each time you're buying something cheap."

    There are no separated "regular expenses"- and "luxury spending"-accounts -- it's all in your head. There's only your net sum of money then and there, and how much you are willing to spend/waste. Sure, if you make up the rule "I can waste 50,- every time I buy something really expensive", you will end up wasting less money, simply because you make fewer expensive purchases. But that's besides the point.

    The fact that getting the big, shiny thing right away might be worth more to you than getting some new shoes right away, is a valid point, though. But it probably doesn't account for the whole effect. We can easily imagine a scenario where you make a big purchase without any emotionally importance to you, where you would still accept bigger wastes associated with the purchase.

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  5. I think ukorrigert has a point here, but it's still interesting. I've never really thought about this and I can picture myself doing the exact same thing :p

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