Yesterday, I bought a sandwich at a Subway store and really enjoyed it. Today I bought the same sandwich at a different Subway store just a mile away, and didn’t enjoy it at all. The reason I didn’t enjoy it was that the second sandwich cost me $2 more than the first, though they were the same sandwich, the only difference being where I bought it. Instead of just enjoying the taste, I felt cheated. That got me thinking about the idea of the economic value, or how much we are willing to pay for something, and what affects our enjoyment of something we spent money (a measure of our own economic value) on.
The variables I am going to introduce in this conversation are: utility, scarcity, satisfaction, convenience, sellers’ and buyers’ markets, buyer’s remorse. What determines how much you are willing to pay for something, or how much satisfaction you get out of owning or using that something, and whether or not buyer’s remorse sets in later? Another way of looking at the whole question is how are prices set. Rather than attempt to give an economics lesson, I will play with some familiar examples.
In my Subway example, the main factor that caused my disappointment was that my expectations were frustrated. Yesterday I paid a certain price, and today I expected to pay the same price for the same thing. But not only was the price $2 more, which in and of itself is a minor issue, rather that $2 represented a 40% increase in the price of the object, and I think I’m terms of percentage increase rather than flat dollar increase. If the object had cost $100 and somewhere else it was $102, I would barely have noticed that difference, but a 40% increase is like paying $140 for a $100 object. Even somebody wealthy would notice and be angry about that. Was it worth the price–to me–I paid today? It would have been if I had not expected it to be $5.01. But while I was tempted to refuse the sandwich, I paid, and then went to the other subway to make sure that I was not mistaken. (The clerk at the cheaper store told me that each owner has discretion to set their own price.) The opposite of this feeling is the satisfaction I get from remembering what I paid for a brand new Vizio 50″ 4K TV with Smartcast! It was advertised at the same price on Vizio’s and Best Buy’s website–$440. On Walmart.com, for only 1 day, it was advertised at $300, and that was what I paid, delivered to my door! The theory of Cognitive Dissonance might dictate that the more I paid for something, the more I should enjoy it, but economic reality declares “everyone loves a bargain.” Now, what if someone decided to upgrade their TV to 70″, and sells the exact 50″ model I have, on Craigslist for $150 just a week after they bought it? DON’T GO THERE.
In a capitalist system like the United States, the so-called Market–what buyers are willing to pay–sets the prices for most things. Sometimes that price is totally out of proportion for what the intrinsic value of the item is and yet if people were not willing to pay it, the price would have to be lowered, sometimes significantly. The best example I can think of is movie popcorn. When you think about the materials and even the labor that went into producing popcorn in the movies, and when you think of the price they charge you at the movies, for it it would have to be considered one of the most expensive per-capita items in the world. Why then are people willing to pay such a price? Because the scarcity of something, especially when that something is paired psychologically with the experience through smell or taste, people don’t care about the actual price as much as they care about the pleasure they’re going to get from enjoying the purchase.
The scarcity value of anything is related to both supply and demand. If the movie-going public decided to eat healthy all the time, and stopped buying popcorn, the theater owner would have to drop the price to some point which overcomes buyers’ health concerns. Lack of demand creates a “buyers’ market“–lowered prices. On the other hand, if health was not an issue, but some kind of fungus wiped out a year’s worth of popcorn, the drop in supply (with demand constant) would result in increased prices–a sellers’ market. So far, I’ve kept it simple, focusing on just the variables of supply and demand vs. price and satisfaction. It gets a lot more complicated when additional economic factors–like taxes, interest rates, availability of land and location–influence how much buyers are willing to pay.
When something is cheap enough to be bought with cash–like a TV or a sandwich– pricing is relatively simple. The opposite case is real estate. I moved from Wenatchee, WA. to Spokane, WA. in 2015, mainly because a house in Spokane cost about 60% of what an identical house in Wenatchee would cost. Why? The main reason was that Wenatchee was nestled between the Columbia River and mountains–they ran out of room to build, i.e. supply couldn’t keep up with demand. The Spokane area has vistas and huge tracts of undeveloped land. But prices also differ significantly within Spokane. Homes in the most desirable neighborhoods are far more expensive than in neighborhoods less desirable.
One of the biggest price factors in real estate is interest rates. That is because virtually no one buys a home for cash, virtually every homeowner has a mortgage and they are more concerned with what the monthly payment is then what the absolute cost of the home was. Because of the way mortgages work, which is too complicated to go into here, interest rates play a huge part in how much the monthly payments are. Income taxes and real estate taxes also play a part in the cost of a home but much less of a part that interest rates. The so-called mortgage interest tax deduction is wildly overrated. The vast majority of people can’t even claim it, though they assume they can, and the real estate industry has convinced buyers that somehow or other they’re saving money by buying a home over renting. That’s what’s known as marketing. The marketing in the real estate industry is very successful, but their success pales in comparison with the marketing of the so-called higher education industry. That’s a rant for another day.