The reverse effect works too. When an overhead cost drops, people consume crappier versions. Free online news is a striking example. If you walked down to the news stand and paid $0.75 for a physical newspaper and the content was all Clickhole listicles you'd never buy it again. But people consume plenty for free.
That's not the reverse effect, that's supply and demand, and people forgetting opportunity cost of time. Newsstands sell plenty of junk like US Weekly.
I thought this was just common sense. Suppose you're buying necklaces.
Today: Gold $10; Silver $0.10
Tomorrow: Gold $1010; Silver $1000.10
By adding a constant to both prices, the price ratio no longer remains aligned with the underlying value ratio. Assuming you have to get one necklace each day, there is less of a decision tomorrow than there is today, because silver is overpriced relative to gold. The correct prices for tomorrow should have been "Gold: $1010, Silver: $10.10", so you're effectively getting more scammed by going with silver.
I'd agree that once presented with as stark an example as yours, it is common sense, but it takes some insight to create such a thought experiment in the first place.
> when the prices of two substitute goods, such as high and low grades of the same product, are both increased by a fixed per-unit amount such as a transportation cost or a lump-sum tax, consumption will shift toward the higher-grade product. This is true because the added per-unit amount decreases the relative price of the higher-grade product.
> Another example is that Australians drink higher-quality Californian wine than Californians, and vice versa, because it is only worth the transportation costs for the most expensive wine.
My unscientific observation has been that the opposite holds for French wine. They seem to ship the US their worst, but it hits our shelves marked up 4x what it'd be in France.
Maybe it's a branding thing, and French wine's got enough power in that department that they don't need to send us good stuff to move product, at least at the lower end. Maybe with some French writing on the label low-price-shopping consumers are equally likely to buy it whether or not it tastes good, so there's no reason to send anything but the worst they have. Other European countries seem to have no trouble shipping us nice wine in the lower price tiers, but then they're not France.
In reality there's a lot more in a product than just good and bad.
Especially with wine, where it is not actually so clear that a true quality ordering exists, all sorts of other effects are at play. For example, we know how the signaling value of price overrides some true quality variables.
In economics, its important to know these simple models and their outcomes, but it is equally important to know when other effects are at play, or when assumptions do not hold
So that's why I go broke on vacations... I want to eat somewhere cheap and the wife says, "No, let's go to the expensive joint... we've already spent $x getting here, so an extra $50 won't make a difference!" Now I have a name for the phenomena.
No. The sunk cost comes into play in explaining why we've gone to Disney World three time too many simply because we bought some multi-day package years ago. I hate Disney. She hates Dianey. But, we gotta use up the stinking tickets.
Uhm, I'm not an economist but how is this a "theorem"? What is the theory, what are the axioms, where is the proof? This seems like an empirically observed trend.
there is some basic arithmetic in the article. imagine the cost was raised by $100, then prices of beans would be $101.5 and $103, i.e. pretty much everyone would go for higher quality. gradually decrease the premium, and you will gradually decrease the number of people who prefer the higher grade product in favor of lower price. this is pretty much it. quite simple and neat observation, actually.
"the harder the punishment, the harder the drug" is another very important non-trivial observation, missed by most people.
Did you read my comment? That's exactly what I wrote. This is not a "theorem". Theorems live inside theories, they're logically implied by axioms of the theories. That basic arithmetic proves nothing of the sort.
Then it is a theorem, as it is tautologically implied by certain axioms imposed on preference relations or choice correspondences, such as completeness, transitivity and a notion of continuity.
Since the whole theory won't fit in one wikipedia article, I suggest you read the first chapters or either
a) Mas-Collel, Whinston and Green
or
b) Kreps, Microeconomic Foundations I (not the old undergrad book from him)
This would provide you with the theory to understand this result in a more mathematical correct way.
"Theorems live inside theories" - sorry, didn't get that.
axioms:
* given same price, consumer goes for higher grade product.
* as relative price difference decreases, some consumers start going for higher grade product.
* rules of arithmetic.
in any case, it seems that we have appreciation for different things. you prefer detailed verbosity, i prefer a simple idea that can be easily understood.
great and profound ideas are not necessarily complex, many of them are quite simple. let's keep them that way.
> Another example is that Australians drink higher-quality Californian wine than Californians, and vice versa, because it is only worth the transportation costs for the most expensive wine.
As a person who loves Belgian beer, I came to this realization when I was on a bit of a beercation there. For the most part, the good Belgian beer makes it here. When I'd try beer from breweries I hadn't heard of while I was there, it was mostly worse than the Belgian beer I had tried at home.
I don't see anything in the article about the extent to which this effect has been observed in the real world. Is it another example of economists assuming that people are idealised rational actors (who would prefer a 1.6x coffee bean premium to a 2x, to take the example in the article), or is there some hard evidence that it explains the real behaviour of real people?
Most of the reaction against modern economists for assuming rationality is just meme repetition. Yes, this is an accurate criticism of a tiny portion of modern economists, and of many economists of prior eras. One of my favorite books, Kahneman's Thinking, Fast and Slow, is a prime example of how pervasive this meme is -- he seems completely unaware that the critique has largely been integrated into the field well before the time of publication. The assumption of rationality has been replaced by assumptions around bounded rationality and cognitive bias.
Modern economic theory is not some abstraction that doesn't resemble the real world, even in cases where the empirical evidence is as-yet weak (which it's not in this case, as is apparent to anyone who reads the whole entry).
Maybe I had pretty biased professors, but in my study of economics, there was no standing assumption that individuals are rational.
Rationality is an observation of aggregate behavior, rather than individual. This is pretty robustly observed. It is interesting because this is in spite of the glaringly obvious observation that most people are not rational at all times (though many people are sometimes rational). Thus it is a useful abstraction to reason about rational individuals, though I have never been exposed to a serious claim in academic economics that individual human beings are rational.
The interesting results of behavioral economics are many, but they primarily give us proof of the already-known fact that individual humans are often irrational. The interesting part is not that humans are individually irrational, but how.
Behavioral economics makes the observation of aggregate rationality even more interesting, because many irrational actors can cause aggregate rationality.
If you would like my musing about how it is that what I have said above is so often misunderstood, then I have some thoughts below.
In my academic experience, all of my intro level professors took pains to ensure we understood that we were learning useful models, and that rationality is an observed phenomenon in aggregate. My intermediate level professors often didn't take as many pains to make this clear, but did make similar explanations. For anything 300-level or above, we never really discussed this topic, as the professors assumed we had already learned such.
Based on my observations, I would guess that most people who do not take a full course load of intro and intermediate economics do not have drilled into them that rationality is not something we expect of individuals, despite it having a lot of explanatory power in aggregate observations.
Additionally, as with all fields, those who practice often forget what is taken for granted in the field. Among economists, unless one has significant experience teaching economics to beginners, I expect it is not a common thing to preface every statement with the type of 101-level introductory remarks that would help to remove such confusion.
Additionally, economics seems to me to be plagued with jargon that are homonyms with common words in the vernacular. E.g. "cost" to a layperson often means "value denominated in currency, which I might pay to someone to acquire a specific good or service" or "the amount my supplier paid for the thing I am purchasing, such that their cost is less than the price that supplier charges me", whereas to an economist, "cost" is pretty much always going to mean "opportunity cost"[0], which is the value (to the entity making the choice) of the next best alternative. This sort of homonymity is rampant in economics jargon.
Finally, there is a pervasive assumption in economic thinking of "ceteris paribus", or "all other factors being held constant" (technically "all else equal", but give me some leeway in the translation to capture intent a bit better). Most theories, models, and statements in economics are going to be statements about a single factor/observation with a magical "nothing else can or will change" condition applied to the entire universe. This is, obviously, a huge over-simplification, but one that is useful for discussion.
In summary, all models are wrong, but some are useful. Economists often discuss in terms of models and the way they discuss uses words you think you understand but you don't, unless you study economics (not a dig, just a truthful observation of laypeople using jargon - see a recent SMBC for non-economics examples[1]).
> Thus, opportunity costs are not restricted to monetary or financial costs: the real cost of output forgone, lost time, pleasure or any other benefit that provides utility should also be considered an opportunity cost.
"The effect has been studied as it applies to illegal drugs and it has been shown that the potency of marijuana increased in response to higher enforcement budgets,[2] and there was a similar effect for alcohol in the U.S. during Prohibition.[3] This effect is called Iron law of prohibition or Cardinal rule of prohibition.
Another example is that Australians drink higher-quality Californian wine than Californians, and vice versa, because it is only worth the transportation costs for the most expensive wine.[4]"
Those don't seem to be the same effect as buying fancier coffee because it seems like a comparatively better deal per pound. Prohibition makes a product hard to get in desired volumes, beyond just price, so you want as much as you can get when a window opens; you can dilute it yourself at home later. It may be the case that demand an't be satisfied by buying weak lots in low quantities.
In economics, "price" is pretty inclusive. Price is usually considered in terms of opportunity cost, and dollars (or other currency) are a nice proxy to use.
But, the thing you think is a confounder here "prohibition makes a product hard to get in desired volume" is pretty much equivalent to an economist as saying "the price went up". There is no really meaningful difference. I have to expend more - either currency (to some bootlegger or intermediary, to cover their risk), time/effort (to find and get to a seller), or risk (I might get caught and go to jail - we can put a price on imprisonment).
Thanks. I did read the article and noticed the examples that you referred to.
To clarify: I just don't see where the evidence for any of these claims is accessible. Four of the six references don't appear to be available on-line. Of the two that are, one is a brief summary that leads to a paywalled FT article that I can't read, and the other is a ~200 pdf economics textbook.
I'm happy to accept that a price differential changes when a constant is added to both prices. But I do question whether people in the real world will switch to a different type of coffee bean because the differential goes from x2 to x1.6. And I wanted to know more about the real-world circumstances in which it had been observed.
I might be pursuaded that the market for illegal drugs/alcohol could exhibit this effect, but it would be interesting to know how how, given that illegal products are probably going to be subject to other effects not shared by legal products, biases and selectivities were compensated for.
The fact that the sources are not easily accessible to you for free does not negate the fact that there are cited sources explicitly disproving your assumption (that this is just economists making things up).
> Thanks, I also read the article.
I'm not sure the extent to which you considered this, but in this context it's hard to read that sentence without making you sound like a jerk.
> I'm not sure the extent to which you considered this, but in this context it's hard to read that sentence without making you sound like a jerk.
Did you consider the possibility that I was simply thanking dyeje for their reply, and confirming that I had noticed the examples that they referred to? Assumption of good faith, etc? Nevertheless I've edited my reply to hopefully make my intended meaning clear.
> The effect has been studied as it applies to illegal drugs and it has been shown that the potency of marijuana increased in response to higher enforcement budgets...
If the price of all marijuana goes up, then I bet overall usage of it goes down even if the individual potency goes up.
Depends... if quality goes up, sometimes that grows the demand for a product. Kraft Parmesan convinced me I didn't like Parmesan for the longest time...
Similar to an even exchange in chess. If you’re behind it’s a good deal, if you’re ahead it’s bad. Of course evaluating value taking into account positions (and thus determining whether an exchange is really “even”) is not straightforward.
I don't consider myself a good chess player at all, but I always thought the opposite way: When I'm ahead, I'm willing to whittle down both sides with even trades until they are left with no options and can be checkmated. When I'm behind, an even trade feels scary - I'm looking for a way to catch up.
Am I missing some reason why it would be the opposite?
This seems wrong: an even exchange does not change absolute balance but magnifies relative balance, which you do not want if you're behind.
Let's say your "strength" is simply the sum of the value of your pieces. The losing side has a strength of l and the winning side has a strength of L.
The losing side loses by l-L in absolute terms, or (l-L)/(l+L) in relative terms.
An even exchange of value k makes it go to (l-k)-(L-k) = l-k in absolute terms (no change); and to (l-L)/(l+L-2k) in relative terms. (l-L)/(l+L-2k) < (l-L)/(l+L).
To take an example, if the situation is white : two pawns and black: one pawn, going to white: one pawn and black: nothing is a bad deal for black (the losing side)!
It doesn't sound obvious or universally true to me. For example: what if the expensive product is of only 1% better quality than the cheap product? Will people who use the expensive product not think that they are paying too much for too little gain, and switch to the cheaper product?
The point is that even when there is a fixed price gap between higher quality and lower quality goods, the rationale to buy the higher quality gets stronger as that gap becomes smaller proportional to the price of the products.
It's not that people always buy the more expensive product.
I wasn't clear. I suspect that under certain conditions (price, relative quality etc), and at a certain increase of price, people will switch to the cheaper product because the quality difference isn't that much.
I'm not sure the effect is logically sound -- before the price hikes you weren't willing to pay a dollar more for name brand (or premium drugs etc), but after the price hike you are? I'm not sure if the authors have a mathematical model supporting the decision, or are just observing illegal drug markets and generalizing.
That's not what is being claimed. The _ratio_ of high quality to low quality products shifts in favor of higher quality as the prices of the two equalize due to fixed costs.
> before the price hikes you weren't willing to pay a dollar more for name brand (or premium drugs etc), but after the price hike you are?
Imagine that 10 normal people and Bill Gates want to buy bottles of wine. Bill goes for a bottle of $6000 Richebourg Grand Cru, and the 10 normal people always go for Shitscreek Red, sold for $4. So about 9% of the buyers are willing to pay extra for the name brand.
After the Great Wine Tax Bill of 2021, the prices are both increased by a fixed per-bottle amount of $6000. So now the Richebourg costs $12000, and the Shitscreek costs $6004. The 10 normal people migrate to beer, and Bill Gates still buys Richebourg. So about 100% of the buyers are willing to pay extra for the name brand.
That's not what the effect is about. The effect is about normal people becoming more likely to choose the expensive one because it appears to be "less 'more expensive'", because they judge ratios instead of absolute values.
A similar irrationality is when people will do an extra hour's work to save $50 off a $100 purchase, but not to save $50 off a $10000 purchase.
So let's say you'd have to pay a dollar more for a higher quality product that costs two dollars. That's twice the price, and hard for you to justify.
Now, imagine that someone puts a tariff in place so that the low quality product now costs ten dollars, and the higher quality product costs eleven dollars. Sure, you might still buy the lower cost product, but if you are going to buy the product at all, the incremental cost of spending eleven dollars instead of ten dollars seems much more worth it. As long as you have to spend ten bucks anyway, might as well spend eleven and get a higher quality good.
