Tuesday, October 6, 2009

Prices and Bulk Purchases

There are many distorted views when it comes to prices and the benefits we receive from the goods we purchase. One such view is something I like to call the Sam's Club effect. I am certain that it has a different name as the concept is not that original. To learn about the other views you would need to read my book, "Feminomics: Irrational Actors in the Market Place". Anyway, the Sam's Club effect is basically a real world example of diminishing returns.

Take for example something which you can purchase at any grocery store across Alaska. Something such as mayonnaise. You typically only need a couple of bottles to last you and your family for more than a month or so. Which is good because mayonnaise has a fairly short shelf life. It is not like a bottle of wine which could last you years if it remains unopened. When it comes time to replenish your families mayonnaise supply you perform your due diligence as a rational actor in the market place and attempt to find exactly which place has the cheapest mayonnaise. You find that the cheapest single bottle of mayonnaise can be purchased at Fred Meyer's for three dollars. However, you can also find at Sam's Club that you can get a pack of three bottles for seven fifty (two dollars and fifty cents a bottle).

Well you want to get your mayonnaise as cheaply as possible and two fifty a bottle is the cheapest in town. So you purchase the three pack at Sam's Club. Then return home and proudly proclaim to your family the great deal you got on mayonnaise, hoping that they will look on with envy for your inhuman bargain hunting skills. Unfortunately, they are less than impressed and point out that the household typically only uses two bottles of mayonnaise before the expiration date on the three pack would pass. You argue that is fine because it is still only two fifty a bottle so the mayonnaise is still cheaper than if you had bought two individual bottles for three dollars each. An undeniable point they all admit. However, they point out that the amount of utility they will receive from the three pack is equivalent to only two bottles of mayonnaise (thanks to the expiration date). So while the price per unit is lower the price per util is substantially higher. Let us assume that one bottle of mayonnaise provides use with one util of utility up to two bottles. After which we receive no benefit at all.

Purchasing two bottles at Fred Meyer's for three dollars each also equates to purchases two utils for three dollars each. However the three pack at Sam's Club costs two fifty a bottle but costs three seventy five per util of utility (7.50/2) since you can only use and thereby benefit from the two bottles. So in fact it was more expensive to purchase the three pack at Sam's Club than it would have been to buy the amount you needed from Fred Meyer's. Since you are not really purchasing mayonnaise but the benefit which it could provide you with. Obviously there are a variety of ways in which you could still come out ahead from the Sam's Club purchase such as selling the additional bottle for one fifty one or more. Or you could change your diet to include more mayonnaise (maybe that would be a benefit?). However, let us imagine for this argument that no such options are available. Well now it should be clear what the Sam's Club effect is. It is taking into account price per unit without considering the marginal benefit we receive from each unit. Basically it is purchasing more than you need because it is cheaper that way. Often when people are bargain hunting at Sam's Club they fail to take into account how they will actually use their five gallons of soy sauce or in this case all that mayonnaise.

Oh... and the book I mentioned earlier isn't real... Sam's Club might not be either... I would have to check...


  1. I get myself in a similar situation in regards to milk, but it doesn't have to do with the price. At least I don't think it does. It has to do with the quantity of milk I need.

    I'm cooking now, and that means that in addition to pouring it over my cereal, dipping my cookies in it, or drinking a warm glass before bedtime, I'm also using it in recipes, and having to buy the milk once a week.

    I only go grocery shopping once a week. That's all I can stand. Really, if you don't believe me read my earlier posts. A grocery store is good for two things and two things only: buying groceries and LOSING YOUR MIND. Unfortunately I'm only good at one thing at a time. So every time I set foot in the Safeway, one of two things happens. I'll either buy groceries, or lose my mind.

    I've been digressing a bit but hopefully you can begin to see my dilemma. If I buy a half gallon of milk, I run out before I have to go to the store next. If I buy a gallon, I still have some left and I don't have to buy it when I go do the shopping but then I run out the week after. If I buy another gallon while I still have some of the first gallon left then my new gallon goes bad before I get a chance to use it all. If I buy a gallon, skip a week, then buy a half gallon all hell breaks loose! I don't have enough milk to dunk my cookies in, and I don't have a warm glass before bedtime to help me go to sleep so I stay up all night worrying about going shopping and not having enough milk!!!

    (Sound of man losing his mind.)

    I know that one factor in setting prices, in addition to supply and demand is the quantity of the commodity. Like you were saying if you buy more of the good, be it milk or mayo, you get more mayo for the money. However if you buy smaller and smaller portions or quantities your specie/squirt o' mayo ratio gets larger and larger.

    If only supply, demand, and my love of milk/hatred of shopping could meet at the pub, work out their differences, and provide me with MILK PLAN B: A 5/6th Gallon Jug. I'd just about pay any price.

  2. Wow, Didymus, that was a very in-depth analysis on Sam's club shopping. I am impressed. It also was a good reminder to take into account the utility of good when shopping in bulk.

    I know I am always tempted by the amazing "bulk bargains" at Sam's but usually manage to take into account how much of the good I will actually use. And being a poor college student this is especially important.

    A good way around this, I've found, is to buy non-perishable goods such as rice, beans, spaghetti sauce, etc. But also perishable goods with a long life time and higher consumption ratio: eggs, meat, etc.

    Now, as far as Udo's milk dilemma...what do we know about demand? There are always alternatives to every want (or need). So though there may not be 5/6 of a gallon to satisfy his particular needs, there ARE alternatives out there.

    For example, he could move to Europe or Asia where volumes are measured in liters. He could then purchase three liters a week (less than a gallon but more than half a gallon). That might satisfy his milk needs, but it is unlikely that the costs of moving to Europe or Asia will outweigh the benefits of getting the precise amount of milk lovin' he needs.

    Another alternative would be to get powdered milk. That will last indefinitely, and can be quickly mixed up as desired in the quantities desired to satisfy his needs. However, the fact that he hasn't chosen this option yet probably means he doesn't prefer the taste of powdered milk more than he appreciates the convenience of it. Either that or he doesn't think like an engineer.....

    OR, he could purchase a gallon a week and invite me over for cookies and milk to use up the excess milk that would be left over at the end of the week. This would allow him to use up the entire gallon of milk so that at the end of the week he could go shopping and purchase a new gallon, and he would still have enough for all his cookie dunking, baking and bed-time glasses.

    This is undoubtedly his best option as he 1) does not have to move to Asia, 2) gets to enjoy the taste of real milk, and 3) would get to enjoy stimulating company and conversation from a fascinating and delightful individual.

    You see? There are always alternatives to every economic decision.