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When Price As A Signal Of Quality Goes Awry…

August 8th, 2012 · 7 Comments
Behavioral Econ · Buyer Beware

It’s often true that high-quality goods have higher price tags, and there are a number of rational reasons why this could be the case- higher production cost, more limited supply, higher demand, etc. Higher demand, in turn, is rationally due to increased utility from consuming the high-quality product. It makes sense then, to some degree, that people tend to take price as a signal of quality- after all, we don’t always have perfect information about every product we are considering consuming, and, even if we did, we aren’t really equipped to handle such vast amounts of information.

The downside of this kind of signalling is that it can be gamed. Behold:

I’m now picturing Dan Ariely as Dogbert, since he’s probably in the best position to provide an explanation. He, along with Baba Shiv and Ziv Carmon, found that not only do people believe that a product works better when given a higher price tag, but also that the product actually does work better, at least as far as a stronger placebo effect is concerned. Their data comes from a series of experiments involving SoBe energy drinks:

In three experiments, the authors show that consumers who pay a discounted price for a product (e.g., an energy drink thought to increase mental acuity) may derive less actual benefit from consuming this product (e.g., they are able to solve fewer puzzles) than consumers who purchase and consume the exact same product but pay its regular price.

Now I wonder whether the VC’s $10 million investment worked better for him than the $100,000 one would have. Something to think about next time you are excited about that big sale, right?

Tags: Behavioral Econ · Buyer Beware

7 responses so far ↓

  • 1 Roland Martinez // Aug 8, 2012 at 6:10 pm

    I am not sure you can use that cartoon as an example of price.
    Let’s say I have a great idea that I am convinced will be the next Facebook. If I invest $100k I will get 180 users and shut down in two months. But put $100 million behind it and it might work.
    I don’t see how you can compare a financial investment and a consumption good based on dollar price.

  • 2 Dan Perignon // Aug 8, 2012 at 8:08 pm

    This isn’t about price so much as it is about consumers expectation and possible ensuing placebo effects due to that increased price. (I think)

  • 3 Kevin Marks // Aug 9, 2012 at 3:49 am

    The assumption that price has a single solution is the flaw here. Price is a fractal. In the classical world this is dispersed across multiple suppliers (you can pay between $1 and $10,000 for lunch in NY or SF by choosing where to eat).
    In the web world this variance is more explicit – witness kickstarter.com, where each project has multiple, parallel prices.
    Or go to the opera, and compare returns to boxes to your name on the new building.
    Price is a fractal.

  • 4 happyjuggler0 // Aug 10, 2012 at 9:06 pm

    Link relevant to JB’s take on the comic strip:

    http://scienceblogs.com/cortex/2007/11/02/the-subjectivity-of-wine/

  • 5 JD // Aug 15, 2012 at 4:16 pm

    “Now I wonder whether the VC’s $10 million investment worked better for him than the $100,000 one would have. Something to think about next time you are excited about that big sale, right?”

    Now I wonder whether the administration’s hundred billion dollar bailouts worked better than the non-bailout alternative would have. Something to think about next time you are excited about that big stimulus bill, right?

  • 6 Rev. Pfloyd // Aug 19, 2012 at 9:09 am

    Well, a $100,000 investment isn’t likely to get many venture-capitalist’s attention anyway. It’s akin to going to your local bank and trying to get a $200 loan.

  • 7 Michael // Aug 23, 2012 at 11:32 am

    This sort of thing is why I despair at the idea that macro models need micro foundations. Macro works; micro doesn’t.

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