Tuesday, July 24, 2007

"-", not "/": In Search of Luxury on the Cheap

Greetings, lotus eaters.

It's been a long time since I've done a post! Let's start this one with some raw data.

Item Egg Chocolate Cheese Wine Car /day
Cheap Price/Serving ($)
.15 1 1 3
Price/Serving ($)
.85 5 7 20 60

Today's post is about how to achieve luxury on the cheap. Some people would approach this subject by talking about secret bargain-hunting techniques: how to obtain the latest and greatest without paying through the nose. However, an often ignored avenue to getting a taste of the "good" life is to spend the money where it counts the most. Something that's worked for me is to start using more of the "-" sign on my mental calculator and less of the "/" sign. Let me give an example to explain what I mean.


Let's talk egg selection. My local supermarkets sell eggs for as little as 79¢ a dozen. These eggs are of decent quality in that they're not risky to your health but, since they're made with such narrow profit margins, every choice the farmer makes has to maximize quantity, not quality.

In the same supermarkets it's possible to buy artisanal eggs for about $5 a dozen. Nestled in post-consumer-recycled cardboard carton packaging on which is printed (in natural, organically-farmed vegetable-based dyes) idyllic odes to the chicken pastoral ideal, these poultry-gems might not quite live up to their billing. However, in this humble blogger's opinion a free range egg is a cut above a factory-farmed egg.

Where Classical Economics Fail

The consumer is left with the following dilemma: should she buy eggs which are six times as expensive, even if they taste better? In an ECON 101 class, the critical question would be "do I enjoy the expensive eggs six times as much?". Since I'd derive less than six times the pleasure from a free-range egg meal than from a factory farmed meal, classical economics says that my utility-to-cost ratio is higher for the cheap eggs, so I should buy those. Many shoppers I see have an ECON 101 attitude as well: they eschew the good eggs because they cost a whopping 6 times as much as utility-grade eggs.

Classical economics however fails as soon as one realizes demand for breakfast is woefully inelastic. In fact, my demand for eggs is met after spending such a minuscule fraction of my capital acquiring them that neglecting the inelasticity of my appetite is absurd. Assuming you have about 2 eggs per serving, the extra cost of having free-range eggs is only 70¢. Is it worth a 70¢ premium to have superior-quality eggs? Absolutely! And yet in the supermarkets I see shoppers clamoring for the best bargain eggs. Why are people being so cheap?

Using the "-" Sign

The root of the problem is the division operator. People balk at the idea of spending six times more, while their finances are affected not by this multiplicative factor but by the arithmetic difference between prices.

From the table at the start of this post, you can see that while the relative price differences between the cheap and expensive items tends to be about 6, the arithmetic differences vary wildly. The premium on buying high quality eggs is two orders of magnitude less than the premium on driving a sports car on a daily basis. Are you willing, therefore, to sacrifice about 100 free range egg-level luxuries each day for the privilege of driving a sports car? If not, you should follow my lead: splurge on the cheap stuff and skimp on the expensive stuff.

Enjoy the good life!



Knaldskalle said...

Wonderful post (welcome back, btw)! You're absolutely right, but I also think that it's so ingrained in many of us to go for the cheap stuff if the perceived difference (advantage) is negligible. Which somehow makes me think of the phenomenon of branding... And bottled water. It's all about perception, somehow.

LeDopore said...

Hi Knaldskalle,

Thanks for the encouragement. You're right that cost savings is a bit of a reflex, and not always a healthy one. Do you have any more thoughts about the relationship between branding and value perception?