Friday, March 21, 2008

Is it Rational To Buy Things Twice?

  • Suppose, you bought a cup final ticket for £30 and then lost it. Is it ever rational to pay £100 to a ticket tout so you can get to see the game?
  • If you bought goods for £5. Is it ever rational to sell them for £1?
Economists note that consumers often behave in an irrational way. In particular we get attached to past actions and therefore fail to maximise our present utility.

Suppose you buy a CD player for £25. This means that you give the good a value of at least £25. However, if it gets stolen, do we immediately go out and replace it? A rational consumer would, because presumably they still will get the same utility from the good. If it was worth £25 yesterday, it should be worth £25 today.

But, in practice many consumers no longer want to buy another CD. They tend to think of the cost as being £50. They think £25 is good value, but to spend a total of £50 is too much. Alternatively, we delay buying the CD player for a long time. However, if we are going to get a CD player, the sooner we buy it the higher our total utility will be.

The problem is that we think of the total cost rather than the marginal cost. The initial £25 is spent, regardless of whether we get a new CD player or not. If we still think it is worth £25 it makes sense to buy the good and not worry about the initial £25 we have lost.

The other problem is that we may buy the second CD player but feel miserable because we have spent a total of £50 which is more than we want. However, we have not made any wrong decisions in buying a second player. We have maximised our utility given the choices facing us.

Admittedly, for some consumers there may be budget constraints; but budget constraints aside the above example is worth careful examination. The important thing is that taking into account past purchases does not help maximise our future utility.

To answer the first question is it worth paying £100 to a ticket tout. - Well it is if you give value to the cup final of £100 or greater. The price of your first ticket is immaterial.

Buying Goods That Go Up in Price

Sometimes we get the opportunity to buy really cheap goods but decide not to buy them. When they go up in price we become reluctant to buy them because we perceive them as being 'more expensive' But, the previous price shouldn't weigh on our decisions. The important thing is whether it is worth paying £40 now or not.
  • If a coat is reduced in price from £200 to £40 we have an incentive to buy it because we think it is 'good value'
  • In another shop the same coat is increased in price from £20 to £40 - we are reluctant to buy because it has doubled in price.
But, it is still the same coat. It's value should not depend on its previous price.

Selling Christmas Trees

Suppose you bought Christmas trees for £5 each and started selling them for £10. However, on Christmas Eve you still have 20 left over. In this case, it is better to sell them for £1 and get £20 rather than not sell any more and then have the cost of disposing of them.
The Christmas tress are a fixed cost. On Christmas eve, the fixed costs are gone, so you might as well get as much revenue as you can.

It is an example of the phrase, 'no use crying over spilt milk'

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