19 June 2015

What is a Bargain?

A while back, I heard the following definition for a bargain:

It is something that you don’t need at a price that you can’t resist.

Although this definition might seem too anecdotic and a bit “unserious”, it is a wonderful illustration of the psychology behind bargains and it explains why sometimes we buy not-so-useful things.

The definition above illustrates that there are two types of utilities involved.

For those of you who don’t know what utility is, it is a fancy word used by economists to describe benefit or pleasure or happiness. For example consuming a bottle of water will bring some benefit / pleasure / happiness to the drinker.

Normative economics takes into account the utility derived from consumption of the good or service. Behavioural economics, however, acknowledges that alongside the benefit of consumption, there is some pleasure (utility) that comes from the purchase itself. This was named by Richard Thaler (1985) as Transaction utility.

In other words, Transaction utility is the pleasure one gets from the deal itself.

Quite interestingly, in the case of a bargain, the consumption utility is close to zero or even negative (i.e. you have to do something with that useless thing and most likely it will bring some head-aches.) while, at the same time, the transaction utility is very high – a price that you can’t resist.

What I believe happens in the moment of purchase is that (at least some) people recognize the low consumption utility, yet can’t resist the great deal. Subsequently, because of confirmation bias, they try to find arguments that support the purchase. More specifically these arguments are directed towards tackling the low consumption utility. In other words, although they realize that the item itself is not particularly useful, they conjure possible uses for the item.  

Thaler, R.H., (1985), "Mental Accounting and Consumer Choice," Marketing Science, 4 (3), 199-214.  

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