Where Behavioral Economics Solves a Problem that Doesn't Exist
By David Henderson
The zero price effect suggests that traditional cost-benefits [sic] models cannot account for the psychological effect of getting something for free. A linear model assumes that changes in cost are the same at all price levels and benefits stay the same. As a result, a decrease in price will make a good equally more or less attractive at all price points. The zero price model, on the other hand, suggests that there will be an increase in a good’s intrinsic value when the price is reduced to zero (Shampanier et al., 2007). Free goods have extra pulling power, as a reduction in price from $1 to zero is more powerful than a reduction from $2 to $1.
This is a quote from page 194 of The Behavioral Economics Guide, 2021, available on line at a zero price.
The authors state this point as if they think that the point they are addressing is a puzzle, or somehow doesn’t follow from, basic economics. But it does.
Put aside the fact, which the authors should know, that there’s no such thing as “intrinsic value.” Value is subjective.
The problem is even more basic. Drop the price from $2 to $1 and let people buy as much as they want, and they buy a given amount, which we can be reasonably sure is greater at $1 and than at $2. But drop the price from $1 to $0 and people can buy unlimited amounts. In fact, we shouldn’t even use the word “buy.” They won’t pay. So it shouldn’t be surprising that people will often value a price cut from $1 to $0 way more than they value a price cut from $2 to $1. The gain in consumer surplus is greater with the price cut from $1 to $0 than with the price cut from $2 to $1.
HT2 Timothy Taylor, aka The Conversable Economist.