“Prices are getting out of hand”
Picture this, you’re on your way home from school and you feel the sweltering heat as you recall this morning hearing forecasts of 38ºC and today being the hottest day of the year. Every time you try to swallow your saliva it’s as if there’s a wall preventing it from going down. The inside of your throat feels like a new scratching post for your kitty, Mr. Whiskers. As you wince in pain, you finally enter your local grocery store. Once inside, you search intently for a bottle of water. You look up and see ‘Isle 3: beverages, water, sports drinks’. You scan the shelves and you see a no-name water bottle priced at $1.00/bottle and right beside that is ‘Fiji Water’ priced at $3.00/bottle.
At this point, three things are probably going through your mind.
- I need this water NOW.
- How can prices be so irrational that things can be drastically different in costs when they serve the same purpose? They’re both just water. and
- If I was at home, I could just get this for free, how are they getting away with selling this?
You purchase the dollar bottled water, quench your thirst and decide to stay in the grocery store for 2 reasons.
- To take shelter from the scorching heat. and
- To further investigate this pricing matter.
Thus you begin to wonder, are the prices for goods rational or can they actually be overpriced such as the ‘Fiji Water’ you saw earlier? There has to be more to this than is what just meets the surface if they’ve been doing this for decades.
This idea of pricing and what consumers will actually pay for certain goods revolves around behavioural economics. The idea of rationality and irrationality. As Dan Arley puts it:
“behavioral economics does not assume that people are rational. Instead, behavioral economists start by figuring out how people actually behave, often in a controlled lab environment in which we can understand behavior better, and use this as a starting point for building our understanding of human nature. As a consequence of this different starting point, behavioral economists usually come to different conclusions about the logic and efficacy of almost anything,”
It’s interesting how there are many different conclusions depending on how you view things and where you start in regards to rationality and irrationality.
The economic concept of the anchoring effect plays a role in the price decisions consumers make. Anchoring is the idea where people are unable to make decisions in plain terms, instead, they use comparisons. In the grocery store example, the anchor was the free tap water. As a result, you are so used to having water for free that the $1.00 bottle seemed like a rational price to pay for the situation you were in, versus the irrational price of $3.00.
Arley, a behavioural economics conducted research in regards to anchors and found that anchors play an extremely important role in consumer price decisions. If the original anchor is low, there will be lower bids, which is fairly evident when you purchased water. In his experiment, he asked people to use the last 2 digits of their social security numbers to bid for wine. Arley found that,
In reality, if you allow people to produce a higher price in mind, then this will make others pay as much as treble the price. People with high social security numbers paid up to 346% more than those with low numbers. As Arley quotes from his book, “Predictably Irrational”;
“Social security numbers were the anchor in this experiment only because we requested them. We could have just as well asked for the current temperature or the manufacturer’s suggested retail price. Any question, in fact, would have created the anchor. Does that seem rational? Of course not”
As you can see from Arley’s example, the price of goods can vary from rational to irrational as easily as people change their perspectives.
Expensive or Expens-NOT:
Now the question is, why do people buy overpriced things when they can buy a cheaper alternative instead? Are these goods priced rationally?
As “Investopedia’s: The Psychology Behind Why People Buy Luxury Goods” states:
“It’s well known that people don’t behave rationally, and considering the enormous consumer debt Americans have, consumers clearly don’t always act in their best financial interests.”
Materialism comes into play when explaining expensive purchases. If a person values luxuries in life, admires people who own expensive things such as cars, homes, clothes or finds happiness through buying expensive items, the more materialistic that person is. This results in the labeling effect. Products are evaluated based on external cues such as labels, recommendations, and prices instead of the product itself.
This study revealed that if you are on the lower end of the materialistic scale you value “expensive” and “cheap” products on a fairly similar scale. Whereas, people on the higher end of the scale valued the “expensive” and “cheap” things more differently in 2 extremes.
As a result, this solidifies the idea of the confirmation bias. This is when you value an expensive item, you expect it to have a higher quality and a cheaper item to be bad.
This explains is how designers such as Louis Vuitton, Supreme, Gucci, Apple and many other companies are able to sell their products at insane prices and continue to have consumers lineup when they release new products. The consumer expects it to be worth the price they buy it at. They acquire these materialistic concepts through these irrational, overpriced purchases but rejustify themselves into rationality through their own happiness and other feelings.
This aspect is where supply and demand determinants play a role in prices and quantities that are set. In this aspect, the demand determinant that is important in keeping these name brand companies on the market is buyer’s preferences/consumer’s taste. This is the idea of finding happiness or just wanting to purchase expensive things. This causes the demand curve to shift to the right increasing demand. This results in an increase in price and quantity.
As a result, these goods may not be priced rationally and seem overpriced, however, emotions and feelings may explain otherwise and counteract these arguments to justify irrational spendings.
Lastly, there are countless things in today’s market that are overpriced. The markups on the items are insane. You’ve probably heard that “Evian” is simply “naïve” spelled backward. Bottled water companies are able to still sell their products at a 4000% markup where a $2.00 bottle only costs about $0.05 to make.
On the other side of things, the notorious king of overpriced goods are the pharmaceutical companies. The infamous, Martin Shkreli was able to take advantage of the monopoly, super inelastic aids drug by putting a 5000% markup price from $13.50 to $750.00 overnight.
Shkreli justifies himself by explaining how it takes very little money to make Daraprim as he lists costs, patients relations, and others. He overpriced and abused this life-dependent drug to make profits. This is similar to what many companies are doing today but to a much lesser extreme that many are able to turn a blind eye. These overpriced products include but are not limited to, bottled water, coffee, movie theatre popcorn, greeting cards and much more. All these items are marked up from as low as 40% to as high as 4000%.
In conclusion, are the price of goods rational? In my opinion, the answer to this question is that it varies to certain extents, but in general for goods considering the amount of inflation that is occurring, it is rational. As long as people use the anchoring effect and turn a blind eye to the mark-ups companies are making on their products, then this irrationality can seem rational. As long as these ideas can be explained and backed up with the happiness the products/goods bring anything, in theory, can be a rational price to pay. However, personally, I do believe that the name brand, ‘hype-beast’ clothing that is trending nowadays are definitely blown out of proportions and ARE overpriced goods as well as anything you can get for free.