The Hindu Business Line : Absolute and relative money

Sometime back, my friend and I visited his friend, a network engineer. His friend was busy scouring for discount coupons in some magazine when we met him. We were visiting him to talk about the high brokerage fee he was paying on his investments. Here was a person who did not mind paying a higher brokerage fee but was spending his valuable time hunting for discount coupons that could save a few rupees off his toothpaste! Why do we behave this way?

A good bargain?

Economists assume that we are concerned about absolute money. Suppose a far away department store offers 50 per cent off on toothpaste that costs Rs 50. Economists say that you should drive to the far away store only if it costs less than Rs 25 to get there and come back. Otherwise, you should buy at your neighbourhood store that offers no discount.

We do not think in those lines — we think in relative money. Saving 50 per cent on toothpaste is a good bargain. And we do not quite calculate the cost that we incur to take the discount!

Marketers take advantage of this idiosyncratic behaviour. Walk into an upscale department store and you will find how. Suppose you want to buy a bottle of wine. You will find that the store has a few bottles of very expensive wine alongside other bottles of not-so-expensive wine. Which one will you choose?

May not be worth it

If you are a typical consumer, you will compare the expensive bottle with the not-so-expensive one and settle for the latter. Exactly what the store wants you to do, because that wine may not be worth the money! It is also the same strategy that real estate agents employ. They first take you to houses that are sandwiched between a dump-yard and chicken farm. And then they take you to a “normal” house.

You and your spouse immediately compare the “normal” house to the ones that you saw before. And you choose to rent or buy the “normal” house — for a slightly higher price.

(The author is a Chennai-based investment strategist.)

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