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I Can’t Afford To Save Money At Costco…

June 12th, 2009 · 15 Comments
Decision Making · Discrimination · Policy

A friend forwarded me an article that made me think of the title of this post. I think the “can’t afford to save money at Costco” thing was popular to say a few years ago, and it makes a surprising amount of sense. In theory, you are getting a good deal by buying in bulk, but there are a number of complications to shopping at a place like Costco:

  • The membership fee- Last time I checked, memberships start at $50. This may not seem like a lot of money, but it could be a prohibitive up front cost for a number of lower income households.
  • Disposable income- Purchasing in bulk in itself requires fairly significant up front investment. I don’t know about you, but I don’t always have a spare $500 lying around to pay for toilet paper for the next 10 years. (And yes, I actually may have done the math on that…a little less than a dollar a roll, one roll per week…ok, it’s now obvious that I know neither the specific cost of TP nor how much is used by the typical household. I somehow still did surprisingly well in my consulting case interviews.)
  • Space constraints- call me crazy, but don’t you have to have a pretty big house/apartment/palace/whatever to even have room for all of the stuff you are buying in packs of 100? Assuming you aren’t getting a storage space for your Costco purchases, this can be prohibitively pricey.
  • Transportation- It’s relatively easy to carry two bags of groceries on foot or bike. For the typical Costco purchase, one basically needs a U-Haul truck. This could possibly explain the popularity of SUVs among soccer moms.

See, it’s not as clear of a win as you would think- and I didn’t even go into the intricacies of having to have the self-control to avoid the impulse purchase of the 1000 Twizzlers, the dozen croissants or the set of golf clubs. (Yep, I have purchased all of said items at Costco at some point.) It turns out that this phenomenon pops up in a lot of contexts. Consider this article, which begins as follows:

Poor? Pay Up.
Having Little Money Often Means No Car, No Washing Machine, No Checking Account And No Break From Fees and High Prices

I did a little brainstorming, and I came to the conclusion that not having money is pretty damn expensive. Some representative examples:

  • It’s generally more expensive to rent an apartment or room by the week than to have the up front money for a lease, since a lease often requires first, last and security.
  • It’s hard (or should be hard, at least) to build equity by buying a home if you don’t have the cash for a down payment…though that may not be a terrible thing nowadays.
  • Car loans and such are more expensive (in terms of higher interest rate) if you don’t make a sizeable down payment.
  • Even something as simple as grocery shopping can be pricier, since higher-priced convenience stores are the most logical option for many people who don’t have cars. (Or, if people go to the grocery store, they take a taxi, which can be pricey. I see a lot of this at the “cheaper” grocery store in Cambridge- people will stock up as much as possible and then call a cab. I am a little perplexed by this, since it is contradictory to my Costco point above, but I think the answer lies in the frequency of food stamp payments.)

The last point is nicely summarized by the following Indexed graph:

As usual, I feel like I have to prove to you that I really do have a point. In this particular case, my point is that liquidity constraints can be very relevant in real-world decision making. Economists generally assume that households can borrow and lend as much money as they need (at the market interest rates of course). They use this assumption to develop models of optimal consumption over time. However, these models become much less useful when you consider the fact that many households do not have easy acess to credit. If you can’t borrow and you don’t have the cash on hand, it doesn’t matter how good a deal something is, since you can’t take advantage of the deal. (This is why demand is technically defined as “being willing, ready and able to purchase.”)

This limitation needs to be factored in when considering policy decisions as well. Consider the following question, courtesy of Environmental Economics:

Would you be willing to pay an extra $1,300 for a car if it saved you $15-17 a month in gas for eight years?

From YahooNews:

President Barack Obama has announced a new fuel and emission standard that he says will, at last, put the United States on the road to a cleaner environment and better fuel efficiency.

Surrounded by leading members of Congress, the industry and the auto workers union, Obama said: “The goal is to set one national standard.” The plan the administration revealed Tuesday would be aimed at saving billions of barrels of oil, although it also is expected to cost consumers an additional $1,300 per vehicle by 2016.

Obama agreed that “it costs money to build these vehicles.” But he also stressed that “the cost of driving these vehicles will go down as drivers save money at the pump.”

According to my calculations, an additional $1,300 up from investment would require savings of $15 to $17* a month to break even over an 8 year life of a car. At current gas prices, that’s 6-7 gallons of gas per month. Worth it?

*at 3% or 7% annual interest rates

If you read the comments on this post, it seems like most economically-minded people go straight to the concept of Net Present Value, which implicitly assumes that people are rational and face no liquidity constraints. However…

Ignoring even the difficulty in making assumptions regarding the trajectory of future gas prices, it is somewhat difficult to make this comparison using a present value model. The reason is that the calculation implicitly assumes that the people buying cars have an extra $1300 lying around to pay for the increased cost of the car, and thus the relevant interest rate (the 3% or 7%) is the opportunity cost associated with not having that money in savings. However, given the state of a lot of households’ finances nowadays, it is more likely that they would be borrowing the extra $1300 to pay for the car, in which case the relevant interest rate would be higher. (I think 8.5% is a typical quote for an auto loan.) Furthermore, the present value model ignores liquidity constraints, as economists typically do, but, given the recent credit crunch, one has to at least consider that there are going to be a decent number of people who can’t make the extra $1300 up front happen at all. So even if the mathematical analysis showed that the extra cost was “worth it” in the long run, that is of little help to the family that can no longer buy a car today…though I suppose that might be okay, since walking *is* environmentally friendly.

I don’t think that I can afford all of the cost savings the government has in store for me.

Tags: Decision Making · Discrimination · Policy

15 responses so far ↓

  • 1 econgirl // Jun 12, 2009 at 9:54 am

    A good point from a Facebook reader. I had forgotten about this:

    With respect to Costco, I think another interesting dynamic at this place is the fact that they don’t accept “major” credit cards (ie. Visa or Mastercard). They do accept American Express, which has historically had much more stringent underwriting guidelines in determining who will receive a card and a historically high annual fee (barrier to … Read Moreentry for poorer people who have the credit to get approved). This means that most people who shop at Costco must pay in cash or a cash equivalent (debit, check, etc.). Therefore customers can’t rely on credit to cover the disposable income issue you raise above, which they can at other grocery stores.

  • 2 stephie c. // Jun 12, 2009 at 10:56 am

    request: a post about iphones! i will leave the specifics up to you.

  • 3 econgirl // Jun 12, 2009 at 11:02 am

    @ stephie: yup, it’s coming. 🙂 For now, here’s an old one…

    http://www.economistsdoitwithmodels.com/2007/09/07/price-discrimination-people/

  • 4 Bob Nease // Jun 12, 2009 at 12:21 pm

    And hyperbolic discounting makes it even worse.

  • 5 judgeetox // Jun 12, 2009 at 12:21 pm

    ‘Live Free or Drive’

    (….reads a sticker on a Dublin bicycle messenger’s bicycle) How true.

  • 6 VD // Jun 12, 2009 at 12:24 pm

    The Net Present Value analysis also fails to account for volatility. the $1,300 is fixed, but gas prices may fluctuate wildly. Some are projecting crude prices to hit $250/barrel by the end of the summer, up from $71 now. So paying the $1300 may be a more attractive option as a hedge against the uncertainty of rising oil prices.

  • 7 Dan L // Jun 12, 2009 at 4:13 pm

    You seem to be working very hard to make a point that I thought was both well-known and non-controversial (at least to reasonable people): That it’s expensive to be poor. For example, I believe that “Nickel and Dimed,” by Barbara Ehrenreich (which I admit I haven’t read) touches on this problem.

    On a tangent: Living in NYC provides an interesting partial simulation of being poor.

    Btw, I wouldn’t stop shopping at Costco even if I lived alone in a 400sf apartment. Also, I suspect that some poorer families share their Costco memberships.

  • 8 Tony C // Jun 13, 2009 at 10:02 am

    Good points on the relevance of liquidity constraints in everyday life.

    For some people, the annual fee isn’t as big of an issue as it first seems, nor is the requirement to use American Express. That’s because Costco and AmEx have a joint deal for membership/annual fees.

    For example, we get our membership plus our American Express card for $50/ year. All of that is on a credit card that gave us $300 cash back last year.

    Then again, we (and others who benefit from this deal) aren’t liquidity constrained, so I think your argument still applies. There is clearly a different demographic in Costco than in Walmart…

  • 9 Rev. Pfloyd // Jun 13, 2009 at 3:24 pm

    I always get a feeling of utter wariness when politicians claim that doing such-and-such policy with automobiles will “save money at the pump.”

    I say this because we should be aware of what percentage of the money paid at the pump goes to the government through taxes (on average around 47 cents per gallon) and we’ve already seen that when we buy more fuel-efficient vehicles, the government has to raise the fuel tax in order to compensate for revenue loss.

    So ultimately we’re not saving money at the pump, per se. What they really should be saying is that we’ll be purchasing less gas. It’s sort of the fuel-consumption version of the money illusion.

  • 10 panda // Jun 14, 2009 at 2:52 am

    “I did a little brainstorming, and I came to the conclusion that not having money is pretty damn expensive.”

    add to that the high probability of having low credit scores, the inability to attain credit cards, ergo the curse of having to pay higher rates than everyone else. e.g. a friend who has to pay exorbitant fees for a lease to own used washer and dryer, since he cannot purchase one- which would be cheaper if he had a credit card. sad thing is he could pay, but the history killed it. the price one pays to get out of the rut…

  • 11 cathe // Jun 17, 2009 at 1:56 pm

    all typical excuses

    1. the cost of toilet paper for a household of 7 is so much that buying costcos cheapest toilet paper by the case saves me enough money to pay for my member ship for the entire year. (dollar store toilet paper doesnt even last one day)
    2. disposable income: $200 per month is what I require in order to stock up on toilet paper, salsa, laundry detergent, ( 2 loads per day min for a family of 7) dish detergent, etc
    3. space constraints: people rarely use their space economically. towels can be hung or placed on the counter in bathrooms and the small linin closets turned into a pantry. top shelves in closets can be used for storage of dry goods. the underside of desks can be used as storage. with creative thinking and reorganizing the possibilities are endless
    4. we drive a paid for van. it cost me $450 from a relative. I have learned to do the maintanence. one costco trip per month is all I need.

  • 12 S.Ping // Jun 26, 2009 at 5:01 am

    Not to mention IKEA. Ever noticed how IKEA will sell you a chair for only $10, but charge you for the legs, back, screws, nuts, bolts and paint separately? In the end, a respectable chair would cost you $35 and about $200 more in great deals, a.k.a impulse buys.

    Another place to really watch yourself when you shop!

  • 13 Dan // Jul 17, 2009 at 8:08 pm

    Well put cathe!

    Most people are eligible to enroll in either regional or employment-oriented credit unions, why shouldn’t low-income people have checking accounts if they choose to do so?

    I get the feeling that you don’t actually shop at Costco and that you probably eat out a lot? To wit, “what do YOU have in your fridge and where did you buy it?”. While people who shop at Costco may indeed buy toilet paper, they are also buying 24 eggs for $2 and 2 gallons of milk for $4 and steak and chicken and rice and ramen and oatmeal and veggies. What’s wrong with getting a friend or family member to give you a ride and utilizing a little invention called the freezer so you only have to make the trip every 7-10 days or so.

    The whole point of the Costco Amex is to give consumers easy access to credit (even low-income consumers) so that they CAN buy at Costco.

    The whole point of your paragraph on liquidity constraints is: “If you don’t have money you can’t buy stuff”… yes… true… and?

  • 14 JW // Jan 12, 2010 at 4:05 am

    While I respect the analysis of the President’s propoesed new emission standards I disagree with the conclusion for four reasons. First, we’re assuming that people are purely interested by monetary costs as opposed to environmental and health costs.

    Secondly, these emission rates are really not as progressive as most folks make them. You’re really looking at your SUVs and Trucks getting the short end of the stick as opposed to your regular sedan. A majority of your sedans already fit the emissions requirements thus making the 1300 dollar point moot.

    Thirdly, we’re not assuming the average commute of the people that are driving the car. A majority of American’s are suburbanites that consume large quantities of oil to get from home to work…so you’re looking at a greater rate of savings.

    Lastly, our current economy is shifting mindsets about products’ lifespan from short run to long run and consumer’s actually have better leverage in the auto industry right now.

    I just bought an 07 Ford Focus that meets the President’s emissions standards for less than 10 grand at an interest rate of 4%…and I’m not made out of money. Granted knowing your banking and your economics is helpful…but I would still argue that this is a prime example of a counter result.

    With that said, I still really enjoyed the analysis, and for poor people with no credit it does not help them…but I don’t think that’s wh0 the policy was aimed for.

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