One of the most interesting survey articles I’ve seen in a long time came out in the recent Journal of Economic Literature, although apparently it’s been kicking around for a couple of years. It is by Colin Camerer, George Loewenstein, and Drazen Prelec on the topic of Neuroeconomics. Excerpts cannot do it justice, but here is one.
Consumers appear to oversubscribe to flat-rate payment plans, for utilities and telephone service and health clubs…A flat-rate plan eliminates marginal costs, and allows consumers to enjoy the service without thinking about the marginal cost. Similarly, travel plans are often sold as packages, making it impossible to compute the cost of the individual components (hotel, food, transportation). Often components of the package are presented as ‘free’ (like Microsoft’s internet browser) even though the claim is meaningless from an economic standpoint, given that the package is presented on a take-it-or-leave-it basis. One can interpret the appeal of ad-hoc currencies, such as frequent-flyer miles, chips in casinos, or the beads used for incidental expenses at all-inclusive resorts like Club Med, as an attempt to reduce the pain of payment. The ad-hoc currency, whether miles or beads, feels like ‘play money,’ and spending it does not seem to exact the same psychic cost.
In experiments, we have observed a preference for prepayment for certain items, even where prepayment is financially irrational…
Perhaps somewhere among these findings is an explanation for some of our mental illness regarding health insurance.
READER COMMENTS
Trenchard Gordon
May 16 2005 at 11:10am
I haven’t had time yet to read the full 94 pages of this article, but the quoted section seems unremarkable. It amounts to the simple recognition that processing information is costly, and that people are therefore sometimes willing to pay a premium for a flat-rate package that relieves them from the burden of weighing every marginal cost.
On what basis can we conclude that such behavior is irrational, or that consumers “oversubscribe” to such packages?
David Thomson
May 16 2005 at 4:02pm
A typical consumer only has so many hours in a day to determine the best deal. They may very well “oversubscribe” to package offerings—but there’s a point where the extra effort simply isn’t worth it. Traveling is stressful enough without spending hours worrying about each and every financial aspect of the trip. Isn’t my time valuable?
Bob
May 16 2005 at 6:41pm
Coase strikes again.
Tom West
May 18 2005 at 4:10am
How about people are rational because they know their enjoyment of something will be lowered by the automatic reflection of the opportunity cost for the item?
Once they’ve paid a flat rate for something, there is no tradeoff between enjoyment and price.
I don’t mind that economists use “homo economus” to model economics, without them economists would sound a lot less authoritative. However, it scares me when economists suggest policy based on “homo economus” rather than on human beings. If somebody listened to them, people could get hurt :-).
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