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?
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.