The Fallacy of Relative Price Evaluation
We’re just back from an end-of-summer trip to the beach. A good time was had by all, and the kids headed back to school this morning. While on the road, I had an interesting experience with the concept of relative price evaluation, and I wanted to share a few thoughts here.
How people evaluate purchase prices
For a bit of background, I recently finished reading Predictably Irrational by Dan Ariely. In case you’re not familiar with it, this is a fascinating book on behavioral economics that’s written for “everyman,” and which has graced both the NY Times and Wall St. Journal bestseller lists.
In his book, Ariely talked about a variety of topics, including our tendency to view prices in a relative context. As an example, he talked about the purchase of a pen vs. the purchase of an expensive suit. If you could drive 15 minutes across town to save $7 on a $25 pen, would you do it? Many would. But what if you could make the same drive to save $7 on a $495 suit? Many wouldn’t bother.
Ariely then asks:
“Is 15 minutes of your time worth $7, or isn’t it? In reality, of course, $7 is $7 – no matter how you count it. The only question you should ask yourself in these cases is whether the 15-minute trip across town, and the extra 15 minutes it would take, is worth the extra $7 you would save. Whether the amount from which this $7 will be saved is $10 or $10,000 should be irrelevant.”
Our experience
My own experience with this came when we arrived at our destination. We stayed in a beachfront hotel, but the parking deck was across a busy street with no crosswalk. We could park there for free, or we could opt for valet parking for $10/day.
Given the amount of money that we were already spending to stay at the hotel, I was tempted to go with the valet parking. After all, what’s another ten bucks per day? Just a drop in the bucket. But then it hit me…
If we had been staying at a cheaper hotel, there’s no way I would’ve willingly spent $10/day (plus tips) for valet service. After all, we only needed the car about once per day. Why should I spend ten bucks to save an extra three minute walk across the street to the parking deck?
Lessons learned
I think the lesson here is that you need to boil your buying decisions down to their most basic level. Look at the actual dollar amounts involved instead of viewing things in a relative context. If you don’t, then your high dollar purchases will almost certainly wind up costing you even more.
This isn’t to say that you should automatically drive across town to save a few bucks. Rather, you need to consider the value of your time and the added cost (gas, wear and tear, etc.) vs. the actual amount to be saved and make an informed decision.
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Filed under: Frugality
About the author: Nickel is the founder and editor-in-chief of this site. He's a thirty-something family man who has been writing about personal finance since 2005, and guess what? He's on Twitter!
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9 Responses to “The Fallacy of Relative Price Evaluation”
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August 5th, 2009 at 10:24 am
The best is when one gas station drops their price by 20 cents, and it’s publicized all over the city. People drive for 50 miles to save that 20 cents on gas and line-up for hours. Nice. Come on folks, you’re wasting your money! The most you can save is 20 cents X 20 gallons = $4 bucks!
Best, RB
August 5th, 2009 at 11:25 am
RB,
I do this all the time with gas. I will waste 10 mins of my time getting to a gas station that is 4 cents cheaper a gallon which saves me a whopping 60 cents on filling up my 15 gallon tank!
It is stupid, I know it, but for some reason I can’t stop!
August 5th, 2009 at 3:10 pm
Interesting read. At some point, we are all slaves to the bundle of wiring we were born with. Right or wrong – our personality and behaviors set the outcome to many of our decisions – financial ones included. I consider myself a person of decent intelligence, but I make decisions (expensive decisions) that just don’t add up sometimes.
I recently had two items that I needed to return to a store. A $10 dollar item from a large home improvement chain and a $40.00 item from a small local shop. Both items were never used and were in the original (unopened package). I had the sales receipts for both.
When I tried to return the $40.00 item to the local shop I got instant static. I was dealing with the same person that sold me the the item (the owner) and he did not want to return it. He is convinced that the product will work for me and that I was wrong to return it, even though I don’t want it. I left the store with no objection. I didn’t want to deal with the conflict – even for 40.00 bucks. I was able to return the 10.00 dollar item to the big store just fine, and if they would have given me crap I would have screamed and cussed and yelled at every manager in the place. I wouldn’t have taken “No” for answer. I would have fought to the death for $10.00 dollars at this place when I wasn’t willing to argue over $40.00 at another place right down the street…
Whats the difference? Why does the fact that one of the stores happens to be small and locally owned matter? I think the local guy was just more real to me – it was more personal and I didn’t want to put him out. So I put myself out instead…
August 5th, 2009 at 3:14 pm
I can say that I think about this all the time. This book sounds interesting. The mindset that we has humans seem to have is that our own time is free. Therefore we will go thru great lengths to save a buck. But is our time it really free?
August 5th, 2009 at 4:38 pm
I honestly never thought about it this way, but the point of the post is totally correct.
It’s more pronounced on vacation though because our defenses are down and we’re not *supposed* to worry so much about money when we’re away having a good time.
We just had a similar experience and went with the lower cost option, yes even on vacation. We were at a hotel that notified us upon arrival (NOT mentioned on their website) that there’d be a $15/day charge to park at the hotel, which would include valet parking. This was implemented to “save jobs” at the hotel. We chose to park at the public parking garage accross the street at $10/day. We figured $5 a day (plus the tips the valets would have expected) were worth parking off site.
Turns out it was better than a good move, because we never moved the car the whole time we were at the hotel. We’d have been paying extra money for no purpose.
August 6th, 2009 at 12:34 pm
I’ve fallen into this trap in the past when I used to take out service contracts because it was “only” X dollars more. When you compare the price of the service contract relative to the price of the appliance, it seems minuscule. But a dollar is still a dollar, and we shouldn’t fall for relative pricing.
August 6th, 2009 at 3:24 pm
Ha ha… I love it!
To this day my father will drive all over town to save $.01/gallon on gas. I just don’t understand the thinking. The only time I’ll go to one gas station over another is if it is right down the street and is charging less.
This concept is something that will benefit us immensely… but we ALWAYS have to keep it on the forefront of our minds, or else the normal patterns of psychology will take over.
September 3rd, 2009 at 9:16 am
Very interesting point!
About the $7 savings on a $25 pen vs. the same dollar amount on a $495 suit: That discount would allow you to buy two or three pens, but it would not be enough to justify buying two suits. Therefore, IMHO, it might be worth the drive across town to nab the discount on the pen, assuming you took advantage of the savings and bought more than one.
As for the parking…what would’ve made up my mind to spend ten bucks more is the “busy street with no crosswalk” factor. It’s not worth risking your life to save ten bucks.
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