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It’s all about emotional excitement.

B. Venkatesh

The other day, my friend and I went to a shop to buy him some formal trousers. He found just one trouser that he liked. The salesperson then told him that he could get two shirts free if he bought another trouser. So, my friend spent Rs 1,250 to buy another trouser that he did not quite like just to get two shirts worth Rs 500 free! Why did he engage in such value-destroying purchase?

Classical economists would cringe at such behaviour. If my friend acted the way classical economists would want him to, he would have bought two shirts at another shop for Rs 1,250 or more. That way, he could have had a trouser and two shirts that he liked.

Instead, my friend bought a trouser that may now gather dust in the back of his wardrobe and two shirts that were not value-for-money. But my friend is not alone. All of us behave the same way when we it comes to buying goods, especially when they are free. That is why businesses use such marketing ideas to improve earnings.

Take Amazon. If you buy two books, the online retailer offers you free shipping on the second book. So, you end up buying another book that you actually do not want just to save a few dollars on shipping! Of course, any discount you may get and the free shipping will help you rationalise the purchase.

Our behaviour is similar in the stock market. Consider two stocks- A & B. A now trades at Rs 90 but was selling at Rs 200 in early January. B trades at Rs 400 because of a one-for-one bonus offer and was selling at Rs 250 in January. Which would you prefer to buy? If you are a classical economist, you will buy A, as it trades at more than 50 per cent discount. But people invariably choose B, because they receive a free share!

The idea of getting something free, it appears, is all about emotional excitement, not simple economics.

More Stories on : Economics | Insight | Simple Economics

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