I wanted to make a Chicken Caesar Salad for lunch today. Unfortunately, I put our (never actually) weekly shopping list together in a rush last Saturday and neglected to include cucumber and lettuce. Thus we had neither and I was lacking two essential ingredients for my salad.
One of my housemates was also contemplating our lack of ham (or any other sandwich meat for that matter) and I had reason to go to the bank in the early parts of this week and so it was that we set off. Our little plan was akin to a surgical snatch-and-grab style operation. Neither one of us really wanted to leave the house, but we both wanted our lettuce, ham, cucumber, and banking services just that little bit more than we wanted to stay home. It was with some annoyance then that our short little strike managed to turn into a lengthy adventure with no clear exit strategy.
We went to the Coles at Windsor Gardens. Now, normally I do all of my shopping at Woolworths. I preferred BiLo, but since Coles-Myer deemed BiLo a redundancy I no longer enjoy that option. Ironic then that I now shop nearly exclusively at Woolworths. Today though, we went to the Coles simply because it is next to the bank I needed to go to.
Would you believe that we could not find the iceberg lettuce? We looked everywhere. Three times. Confused as to our inability to locate something so basic, so essential that surely there isn’t a supermarket in the country which doesn’t stock it, we asked a not-quite-friendly storeman where we could find our beloved iceberg. Somewhat grumpily he pointed in the general direction of the fruit and veg section and gruffly said “that way”. I was expecting another round of pointless searching, but the man did actually wander over with us and was quite obviously startled at the distinct lack of anything resembling an iceberg lettuce. He said he would go and find out for us and disappeared through the doors to the staff areas. I suppose I can understand his cranky attitude. He was, admittedly, in the middle of restacking some shelves and it does seem an insane request, along the same lines as “Excuse me, I don’t quite seem to be able to find the cash registers…”
This gave my housemate and me sometime to stand around and look at all the produce that was available. We don’t tend to pay a lot of attention to the specific prices of various goods, we may be ‘poor students’ but we are actually reasonably comfortable and when it comes to food we basically just buy what we want. We have, however, noted the price of some items. For example the short-cut rindless bacon that we buy at least half a kilo of each week sells for about twelve dollars per kilogram at our local Woolies. Capsicum has tended to sell for $3.98 or $4.98/Kg for the traditional colours and nearly double that for the crazy orange and yellow varieties.
And so the $6.98/Kg price tag for red capsicum at Coles Windsor Gardens grabbed my attention and, in fact, convinced me not to purchase any capsicum today. A quick look around the store revealed several other items that were priced at least a little higher than they are at our regular Woolworths. Interestingly the green capsicums were on sale and selling for a mere $3.98/Kg (damn our house’s preference for red capsicums).
The man came back and told us that the lettuce delivery that day had been sent back due to the unsatisfactory quality of the iceberg lettuces and thus there would be none today. I was disappointed, but I both accept and applaud the store’s decision. I would have been far more unhappy and disapproving of low quality, inedible lettuce than I am of their lack of lettuce. So we looked at the other varieties of lettuce and purchased some oak lettuce instead.
That turned out to be a mistake. We tried the oak in the car. I couldn’t quite decide if it tasted more like leaves off a bush that I had in my front yard when I was ten or grass. It is perhaps best not to question what I ate when I was ten. This lettuce, however, was chewy and largely flavourless. It was nothing like the crisp, watery iceberg that I had been looking for.
So, it was decided that we would go to another store and try our luck again. Around the corner, on the path home, is another Coles, specifically Coles Greenacres. I was interested to discover that the green capsicum was on sale at a different price here. A mere $2.99/Kg, nearly a full dollar cheaper for a three minute drive.
They did in fact have iceberg lettuce at this store. It was tiny. Barely larger than my two fists and for its size it seemed exorbitantly priced at $3.47 each. Even less appealingly it was various shades of brown. It looked edible though not long for this world and not nearly as nice as I would normally like. In retrospect it seems silly that I would have tried another Coles, after all they likely get their lettuce from the same place. But, my desire for lettuce was strong and I was even more determined to thwart the universe’s seeming desire to leave me without lettuce. So I grabbed the least unappealing one and headed to the checkouts.
There were lines. Long lines. At all of the open checkouts. My housemate and I stood in a line and discussed, you could say complained (albeit jovially), about the price of lettuce and the fact that a store had actually failed to have any in stock. As I looked around I remembered the green grocer across the walkway. I assumed they were likely to have cheaper and better lettuce than we currently held. So we returned our lettuce to its pile of brown runts and looked for a way out of the store. The options seemed to all involved pushing past someone, be it a little old lady, a fat smelly man, or a scary-looking tattooed guy with a grim expression. So we found some railings to jump and walked across the hallway.
Indeed the greengrocer did have iceberg lettuces. They took us all of five seconds to find. Better yet we were presented with options – we could get our lettuce inside a ‘stay-crisp’ bag or rolling around free. Even better was that the lettuce was cheaper at the green grocer ($2.99 without the ‘stay-crisp’ bag, $3.25 with the bag). The best part was that the lettuces were a decent size, easily more than the twice the size of their inferior cousins across the walkway. They even managed to avoid having brown leaves and stems. We bought a nice-looking lettuce of good size that wasn’t inside a ‘stay-crisp’ bag.
I imagine that by this point you are asking yourself why I have been harping on about this lettuce. It could be that I want to disparage Coles and their ineptitude at ensuring the supply of a non-defective basic good or it could be that I want to expose the blatant profiteering in their price-setting from store to store.
In truth, I have no particular interest in either of these things (today at least). I’ve gone grocery shopping somewhere in the vicinity of one to two thousand times over the last ten or so years. I have no idea how many times I have been to Coles, but I imagine that it at least tops one hundred (Woolworths would be at least twice that, and BiLo many times that). This is the first time I have ever encountered any major supermarket not having such a basic commodity when I wanted it. Their produce may not always be of the quality I want and they have often times not had the seasonal fruit that I had a hankering for (though I suspect this has something to do with my complete lack of knowledge as to fruit seasons and my desire for high quality fruit to be in store whenever I happen to want it). However, they have always had apples, iceberg lettuce, and milk. So, I am happy to give them the benefit of the doubt and assume that I was merely an unlucky individual who got caught out in a one in a million event.
I see even less reason to attack their profiteering. Price-variations can be due to a myriad of events and it is not entirely unreasonable to give some benefit of the doubt to the various Coles stores. Perhaps the Greenacres store mistakenly over-ordered the green capsicums and so chose to set the price lower, or perhaps there has been even less demand for green capsicums at Greenacres in the past few days. Even if it is simple profiteering, Coles is a competitive retailer, on the average and in the long-run I have little doubt that their prices are roughly equal to those of other chains. Any over-all trend is likely to be due to differences in rental costs and other overheads and is likely to be corrected by the market if they are large enough to be noticeable to the average consumer. Furthermore, if I wanted to, if it was worth it to me, I could quite easily go to the multiple stores and determine how I could best construct my shopping list so as to get the cheapest possible basket of goods. I choose to pay the premium on the occasional good to get what I want, when I want it, where I want it. So, I have no actual complaints about their pricing structure. (Tim Harford provides a well-written explanation and discussion of this practice for the layperson, alongside a series of explanations that practically amounts to an Economics 101 course, in his book The Undercover Economist (official site, amazon.co.uk)).
No, my reason for telling this story is to ask a question. Would you have done much the same thing to get the lettuce for the salad you just had to have?
I suspect the answer is, if people actually look at their past activities, likely to be a ‘yes’ far more often than it is a ‘no’. To get my lettuce I spent about an hour and seven dollars. That doesn’t take into account my petrol, wear-and-tear on the car, the other driving-caused externalities (emissions, wear-and-tear to the road, congestion), the increased wear-and-tear on my clothing from being exposed to the weather, the displeasure at getting rained on, or the time and effort that my housemate also expended. How much does all that come to? How much did I actually spend on the lettuce?
Well, let’s start with the cost of the lettuce itself: $2.99, or rather $3. How do we count the oak lettuce that I bought? I never would have purchased it if the initial Coles had had the iceberg that I so wanted. I’m also unlikely to actually use that lettuce now that I have iceberg (and now that I’ve tasted the oak). So, there is an argument to be made for including that in the cost of the lettuce. Except that to make that argument would be to violate one of the fundamental principles of economics – to ignore sunk costs. So, we do not count the cost of the oak lettuce at all (at least in so far as working out if I should have gone to such effort to get an iceberg lettuce). I will look more at why we ignore sunk costs after the remainder of the cost breakdown.
The next range of costs looks at my travel and time expenses. The tricky part here is that I did not go to the store just to get lettuce. I also needed to go to the bank and I needed to get cucumber. To complicate matters further, my housemate accompanied me – she wanted to get lettuce and ham.
Travel costs need to take into account all the costs that I bear of travelling to and from the store. I will deal with the time I spent separately. I travelled for three goods – banking services, lettuce, and cucumber. The amount of extra non-time travel related expenses for driving to the second store were miniscule, so I shall ignore them (it would have been no more than an extra 50m of driving). Since I was equally interested in all three goods, it seems reasonable at face value to suggest that the lettuce was responsible for one-third of the travelling. I travelled about 6Km each way to the Windsor Gardens store, so my total travelling was about 12Km. So at first it seems reasonable to say the lettuce was worth 4Km of travelling. However, if I had not wanted the banking services I could have travelled to my local Woolworths, which as a return-trip would have been a mere 4Km. So, I shall split the 4Km between the cucumber and lettuce, and leave the remainder to the banking services. So, the lettuce was worth 2Km of travelling.
My car gets about 6L to the 100Km, and once you do the calculations this implies that I used about 0.12L to get the lettuce, which given I last bought petrol at 130.9c/L means I spent not quite 16c on petrol for this journey. Hardly a significant amount and far less than I had anticipated, else I very likely may not have bothered to include this amount.
I will ignore the fact that my housemate accompanied me for this part for two reasons. Firstly, I would have gone regardless of whether or not she had and secondly, despite her accompanying me, I still bore the full cost of the travelling – she did not pay me any petrol money or anything else like that. Thus she did not actually change the travel-related costs that I faced.
For the sake of simplicity I will also ignore the other costs associated with the journey. The annual car registration, the initial purchase of the car, and the comprehensive insurance which protects it are all up-front costs and as such have no marginal cost – that is, they did not cost me anything for this journey. I will still have paid those costs regardless of whether or not I made this trip. The maintenance of the vehicle would be a miniscule cost (~$200 per 10,000Km) and the externality costs are not actually borne by me. Whilst I would like to claim to be a conscientious citizen if I am to be realistic then I must admit that the carbon emissions (and other pollutants), the congestion, and the increase in risk of a vehicular accident caused by another driver on the road did not factor in to any part of my decision making process.
What did factor quite strongly into my decision was the fact that it would take time and there were potentially better ways I could spend my time. The whole trip took an hour. A part of that was due to the banking services I desired – about ten minutes in total was extra driving time, and another five minutes in the bank. So, the proportion of the trip that was due to my desire to have lettuce and cucumber was about forty-five minutes. The tricky part here is that my housemate who accompanied me was only interested in lettuce and ham, the entire length of the trip was devoted to those two goods for her.
I will deal with the time I spent first. As discussed above, for me only forty-five minutes of the trip was due to the lettuce and the cucumber. Of those forty-five minutes, ten minutes was travel time, five minutes was spent getting the cucumber (which I walked past and would have completely forgotten about if my housemate had not reminded me. Much thanks to her.) and helping my housemate get her ham, and five minutes was spent in the check-out at the first Coles. That leaves twenty-five minutes that was just me trying to find lettuce. A further seven and a half minutes is added to the lettuce time from travelling and the check-out at the first Coles. That means I spent a total of 32½ minutes getting lettuce this morning.
My housemate had no need to travel further for the banking services and so the entirety of her travel time is split between lettuce and ham. Using the same breakdown I did above (but replacing cucumber with ham), leaves her having spent 42½ minutes buying lettuce.
This brings us to the difficult question of what our time was worth. To simplify things I will assume that 42½ minutes of my housemates time and 32½ minutes of my time are worth the same amount (an assumption that could quite possibly get me into more than a little bit of trouble…) So, how do I assign a dollar value to this time. If I was at work I would want no less than $15 for that half-hour. If a random person wanted to pay me to run around for that half-hour like I did, I would have asked for $20. However, neither of these figures are satisfactory. Had I chosen not to go and instead stayed home, I probably would have been doing a task that $10 or even a mere $5 would stop me from doing (notably watching an episode of The West Wing or reading the latest book I’ve purchased). How can one decide which figure to use? In the classes I have taken we would look at what else could have been done with the time, and what value that use of the time carried – helpfully, there would have been only one other option as to what could be done. Real-life, unfortunately, is not as helpfully clean-cut as a classroom model and there were about ten things I had been considering doing this morning, and so this process is probably not quite as useful and not nearly as simple or straightforward. For a start, some of those options – such as writing a blog post on Premier Rann’s new bikie laws, or reading the rest of my book – are difficult to value.
Ultimately it is probably impossible to pinpoint the precise dollar-value of that particular period of my time. However, since we are talking (mostly) about what I wanted and how I valued that time, I would put a price on it of $12.50. Now, that may not correlate well to my housemates view, but for this exercise it will have to suffice.
That brings the total cost of the lettuce to $28.16 plus a few fractions of cents and some (likely less insignificant) externalities. Of which I bore $15.66 and my housemate paid $12.50
Let me get this straight. We were willing to give over nearly thirty dollars of value for one lousy lettuce?
At no point did we seem to be acting in an irrational manner. At several stages along the adventure we asked one another if this effort was actually worth it. Each time we came to the conclusion that it was in fact worth the next piece of effort.
How does this happen? Why does this happen?
Well, it’s a fairly simple process actually. Rational people – and there is no reason to assume that we did not act like rational people for these purposes – ignore sunk costs and make their decisions at the margin. That is, they will ignore costs that have been paid in the past, and are irretrievable, as largely irrelevant to the current decision and they will make their decision based on the benefit from and the cost of the next unit purchased rather than on a basis of the average benefit or cost.
If someone had come to my door and offered me the lettuce for $15, I would have said no. I probably would have laughed in their face. It is a preposterous amount of money to spend on a lettuce. If they had come to me and asked me to spend a half hour chatting with a friend and walking around for the lettuce, I also probably would have said no. Though, it is arguable that that would be an irrational decision on my behalf. In fact it is far more likely that I would have taken the deal even if I didn’t want the lettuce – if only because I like talking to my friends and am more than willing to do so ad nauseam. Gods-only know why someone would offer you a lettuce. Which leaves us asking, why was I willing to do so when the costs came in small increments?
Firstly, we need to consider the premise that a rational decision will ignore sunk costs. Sunk costs are those costs which have already been spent and cannot be retrieved. So, the cost of driving to the first Coles was a sunk cost when it came to driving to the second Coles. I was willing to spend the five minutes it would take to stop at the second Coles on the way home and pick up a lettuce. That five minutes, taken by itself, was a low enough cost that I was quite happy to still get the lettuce.
Why does it make sense to ignore sunk costs? Consider this: The cost of a replacement item is $3, and you get $5 value from it. If you spend the $3, you have effectively made yourself two dollars better off. How is that affected by the previous decision? The simple answer is that it is not.
There is a more complex way of looking at this that most first year text books and courses seem to ignore. They are right in that the sunk cost in and of itself should be ignored. However, they hold the rest of the conditions constant. That is they assume that the real-cost to you for the first good is the same as the real-cost to you of the second good. This is true, or so close to true as to make no discernible difference, when the good is a tiny part of your overall budget. It is not true if the good is a massive part of your budget. Consider the following example: You only have $20 and there are only two goods you can spend that $20 on – apples and movies. Each apple costs $2 and each movie ticket costs $10. Since you would die if you did not eat at all, the first apple is worth a lot to you, say $1000. The second apple isn’t worth as much, whilst one apple isn’t enough to relieve your hunger it is enough to prevent your death (kids see a doctor and get your parent’s permission before testing that theory), so the second apple is only worth $500 to you. Similar reasoning sees the apples decrease in value. The third is worth $200, the fourth $100, the fifth $50, the sixth $40, the seventh $30, the eighth $20, the ninth $10, and the tenth $5. The first movie you see is worth $160 to you, but after that you are bored of sitting still and the second movie is only worth $100.
So you take your $20 and you think about how to spend it. You have three options for bundles that you can buy. You could buy no movie tickets, one movie ticket, or two movie tickets. If you buy no movie tickets, you will buy 10 apples. This gives you $1955 worth of value. If you buy one movie ticket, you will buy 5 apples and get $2010 worth of value. If you buy two movie tickets, you get no apples and only $260 worth of value. Clearly the best option is to buy one movie ticket and five apples. It will give you the most value for your budget.
If you were to lose six dollars on the way to the supermarket and cinema (and this is effectively what a sunk cost is – lost money, a lost ticket, or wasted time) then you would have only $14 and suddenly your options would change to one ticket and two apples, or no ticket and seven apples. The seven apples are worth $1920, whilst the movie ticket and two apples are only worth $1660. Suddenly the sunk costs are indirectly taken into account.
It is the change in your wealth rather than the sunk costs which may affect your utility function. It doesn’t matter if these wealth changes are because you lost a lettuce or because you bought some silverside.
Admittedly, this is not actually relevant to today’s adventure, the sunk costs did not affect my wealth sufficiently to have any discernible effect on my desire to have that damned iceberg lettuce.
Secondly, we need to consider how today’s adventure was structured. If the costs had been presented up front, they would have been far greater than the value of the lettuce and I would have never been willing to pay them. However, having already spent those costs there was no reason not to spend the next few dollars to get value from the lettuce that was worth more to me than those few dollars. I would still be better off than I was.
And so, by encountering the costs in small increments, where previous costs are irrecoverable we can end up paying nearly $30 for a single iceberg lettuce.
Note One: Much of the above cost can actually be offset by viewing the value in the adventure itself. Firstly, it gave me something to blog about (blogging being an activity I derive pleasure from). Secondly, it was a source of amusement for me and my housemate at the time. Thirdly, the time was spent with my housemate which was enjoyable in and of itself. Fourthly, it allowed me to put some of the economics I have learnt in the classroom into action in my life, thus furthering my understanding (and passion) for the field. Is it possible that all of these benefits, once added in to the mix actually meant that I came out better today than the time, effort, and money cost me?
Note Two: Entertainingly. I forgot to put the cucumber in my salad. I didn’t realise that I had forgotten until I sat down in front of the television to watch an episode or two of The West Wing. At which point the opportunity cost of getting up from my comfortable seat was higher than the value I would derive from the cucumber. So I went without the cucumber. It would seem that the universe does actually win in the end.