A Penny Too Far

Would you buy a 100 million dollar house if you liked it? How about a 100 dollar house… if you liked it? Since most of us can’t afford the former, and will never see the latter, the house we end up buying, if we buy a house, will necessarily be somewhere between these two extremes.

Whether it be houses, cars, milk or bread, there must, therefore, exist an exact price beyond which we will forgo our desire and keep our money.

Granted, while it does seem odd that one penny could break a deal on a transaction involving hundreds of thousands of dollars, like say a house, in reality one penny could. We can follow this logic by asking the question: “Would I still buy this house if it were one penny more? OK then, how about two penny’s more?” Simply repeat until the house is “too expensive”.

For this reason marketers grapple with each penny in the final price of something. They know that that penny may become one penny too much for someone, or some.

Corporations, from necessity, must constantly make decisions based on this fact. They must attempt to squeeze the most return for the buyer and themselves out of each penny. While such decisions can appear to have a slimy greedy feel to them when examined out of context, each of us make similar decisions daily without even realizing it. We could spend an hour walking to the store, which is safer; or we could spend 15 minutes driving to the store with higher risk of harm or death, to save 45 minutes, for example.

In the final analysis the lines are precise. Whether or not we extract resources, buy that thing, indeed every decision we make in an economy ultimately comes down to a line that exists between “not one cent more” and “that’s one penny too far”.

 

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5 Comments

Filed under Economics, Human Nature, Money, Supply And Demand

5 responses to “A Penny Too Far

  1. Your thesis makes sense. There are however exceptions to this rule. For example the gambler who knows that he can not aford to place his final £100 on that horse but due to being addicted to gambling (the thrill of betting) does, non the less go ahead and wager his remaining money. People don’t always act rationally as economists believe. Factors such as addiction or other psychological issues play a part in determining their actions and, sometimes the main part.

    • I’m not sure how the “gambling addict” is an anomaly to this post. Every gambler has a maximum amount that he can gamble.

      Still, you bring up a good point. Gambling is risk, just as other kinds of investment are. The odds in investment are simply better, with much slower returns. I think a good example of your point could, therefore, be found in economic bubbles.

      Here in the US, during the housing bubble, for example, people were taking out loans on their homes and then taking elaborate vacations, buying expensive cars and recklessly speculating on the housing market. But I think people are more rational than you give them credit, at least we should hope that they are for our own sakes.

      Here’s what I mean. I know one person personally that I think was fairly representative of the mindset of many. He took the “equity” from his home and used it as leverage to buy several homes with the hopes that they would “appreciate” and then he would sell. I asked him once what he would do if his investments went south. His answer was very rational. He said that he would “give the houses back to the bank”. In other words, he rightly rationalized that there was no real negative consequence to his actions, but the possibility of great positive consequence… and he, and the many like him, was right. The market did go south and he executed his plan. The only negative consequence was that he had to move out of the house that he had hocked, and into a much larger rental with a much smaller monthly payment. Right now my guess is that his “credit’ is on the mend so that he can try something different. Meanwhile those who were not reckless, including the unborn, are saddled with the real negative consequences of their actions.

      The only irrational ones in all of this, as I see it, are those who think that negative consequences–under whatever guise one removes them–can be removed with positive results.

      I’ve written more on this here.

  2. For the purpose of most discussions, I think it’s safe to assume the rational actor in a transaction, and not use an addict as a stand-in for the rational actor. Addicts are inherently irrational. They are not acting in their own self-interest, short- or long-term.

    Price rationality is entirely logical. It’s also entirely logical to assume that if you roll the dice on multiple mortages (as in the example given above), that the penalty for its failure might not be that horrific a downside as one might initially expect. It can mean credit gets tanked, yes, but that can be repaired over time. It is rational to calculate the cost/benefit scenarios, especially when there are so many ways to soften the downsides that it makes not investing in the scenario given above seem like a mistake.

    That the incentives that exist out there might skew decision-making, well, that’s another rational assumption. Because it’s real, and has happened in both the individual’s case and in larger policy-making decisions.

  3. The example of the man who took out the multiple mortgage’s with the full intent of “letting them go back” speaks volumes to me of our society that looks out only for their “self” interest and not the consequences on those who must “eat or suffer from” his abdicating his obligations and commitments. How can we, as believers in THE WORD, and doer’s and not hearer’s only, ever come to believe and do like that?

    • Susan, we should not expect unbelievers to hold to any concept of objective truth… as in it is objectively wrong or right to one thing or another. For them such “truths” are nothing more than social constructs and the result of the whims of those who can persuade society. (I’ve touched on this before here) What was discouraging to me was that the person who said this considered himself a strong Christian. If his mindset was typical of Christians, the problems facing our society can be traced to a failure of Christianity to be a salt and a light in its own house, much less society.

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