Sunday, March 16, 2008

Is Consumer Surplus Arbitrary

If our willingness to pay for items moves around almost arbitrarily is it a useful metric for determining social welfare? This article describes an experiment in which simply thinking about the last two digits of your SSN dramatically changed individuals' willingness to pay for items.

"Now here we have a nice 1998 Cotes du Rhone Jaboulet Parallel," said Drazen Prelec, a professor at MIT's Sloan School of Management, as he lifted a bottle admiringly. Sitting before him were the 55 students from his marketing research class. On this day, Prelec, professor George Loewenstein of Carnegie Mellon University and I had an unusual request for this group of future marketing pros. We asked them to jot down the last two digits of their Social Security numbers and tell us whether they would pay that amount for a number of products, including the wine. Then we asked them to actually bid on these items in an auction.

What were we trying to prove? The existence of what we called arbitrary coherence. The basic idea of arbitrary coherence is this: Although initial prices can be "arbitrary," once those prices are established in our minds, they will shape not only present prices but also future ones (thus making them "coherent"). So would thinking about one's Social Security number be enough to create an anchor? And would that initial anchor have a long-term influence? That's what we wanted to find out.

you mean to tell me that prices aren't determined solely by supply and demand? that marketing, and psychology might also play a part in determining prices?
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