Bounded rationality and movie theater popcorn

I’m attempting (successfully, so far) to slog through an intercession class at the moment, so things will be slow to nonexistent here until that’s done. However, I wanted to quickly highlight this post by Gabriel Rossman, who’s doing a good job so far exemplifying what economic sociology has to offer.

Anyway, one of the foundations beneath economic sociology is the idea that markets are embedded in non-market social relations. In the case of price discrimination, which as Rossman notes should only apply to narrow situations, we can get a good sense of how people in the aggregate can affect markets in ways they shouldn’t given standard economic theories.

I’ll parse out the train of thought – first, price discrimination (my addition in non-italics):

These pricing practices [services structured to be complex] are forms of price discrimination, which is to say they are ways to customize the price point so the seller doesn’t leave much money on the table relative to each particular consumer’s willingness to pay. It’s kind of like haggling but it works at scale over a large number of consumers.

Price discrimination is a mixed bag. On the downside it pushes consumer surplus close to zero, meaning you always feel like you’re getting ripped off but not so much that you balk. On the upside it increases total revenues and quantity supplied.

Yet theory would suggest that such price discrimination should only exist in areas of monopoly or price collusion. In areas where there is competition and no collusion, price discrimination should be arbitraged by “sophisticated consumers,” who wouldn’t be duped into frequenting movie theaters with eight dollar tickets and ten dollar popcorn. “Myopic” consumers, on the other hand, would be just fine with it. In a idealized, theory as fact world, everyone wins.

Too bad it isn’t true. A lot of firms, and industries for that matter, count on making money from price discrimination. Here’s Rossman’s favorite example of how consumer myopia works:

My favorite example of how consumer myopia works this way is how rental cars now offer you prepaid gas for about 10% less than the price you’d pay at the pump. The consumer may be thinking, wow, $3.90 a gallon is actually pretty cheap compared to $4.30 at the Exxon station, I should prepay for this full tank of gas. What doesn’t occur to this consumer is that this is only cheap if you use the full tank. If you bring it back with half a tank you’re effectively paying $7.80 a gallon. The consumers who appreciate this don’t buy the plan but those who don’t see the hitch may well buy it. As long as the base rental price isn’t too low it makes sense for the rental company to more or less break even on people who pass up this offer and make an easy $20 or so profit on those who sign up for it.

Of course we see this all time. Common vernacular might call it a scam, which it isn’t, but at the very least it’s something I like to call “the gigantic caveat,” or Rossman describes as “shrouded attributes” – in which the true cost of a service is hidden. This is also known as “nickeled and dimed.” What throws theory way off is that most customers know that the market structure is often “rigged”, sort to say, but given bounded rationality make the myopic choice anyway.

Which is to say the rationality of our decisions isn’t dictated by maximizing economic benefits alone. It’s limited by information (do we know we’re getting nickeled and dimed?), finite time (we can’t spend four months out of the year reading every single word of every single contract, nor contemplate our complicity in encouraging every transaction that features price discrimination), and I would argue social relations as well (there are non-market social pressures to engage in economic activity). Individually, and in the aggregate, we often make economic decisions against our own self-interest…either from ignorance, apathy, or because your significant other expects greasy theater popcorn.

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One response to “Bounded rationality and movie theater popcorn

  1. Pingback: A response to what might have been (and still could be) | Punditocracy·

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