The Inexplicable Appeal of “Free!”

1. The Inexplicable Appeal of “Free!” Non-standard decision making Behavioral Economics Udayan Roy

2. Reading • Predictably Irrational • Chapter 3 The Cost of Zero Cost

3. It’s Free!!! • We seem to lose all sense when told that something or other is free • Our ability to make intelligent trade-offs deteriorates when the price drops to zero • We tend to choose a “free” option even when it is clearly inferior to other options

4. Chocolate Experiment • Students were offered the opportunity to buy one chocolate per person at reduced prices • Here are the results:

5. Another chocolate experiment • Each child is given 3 Hershey’s Kisses and then offered a trading opportunity • Group 1 • 1 Snickers bar for 2 Hershey’s kisses, or • ½ Snickers bar for 1 Hershey’s kiss • Group 2 • 1 Snickers bar for 1 Hershey’s kiss, or • ½ Snickers bar for free Most kids took this Most kids took this In both cases, one could get an additional Snickers bar by giving up one Hershey’s kiss. This trade off is popular for Group 1, but not when a “free” option is available.

6. Amazon.com gift cards experiment • One gift card per person • Offer 1: $20 gift card at a price of $7 • Offer 2: $10 gift card for free • Guess which one was the overwhelming favorite!

7. Amazon.com in France • For some reason, amazon.com in France was not showing sales levels that were achieved in all other countries • It turned out that all other countries had free shipping while there was a one Franc (about 20 cents) shipping fee in France • When shipping became truly free in France, sales quickly jumped up to the levels in other countries

8. Free! drives us crazy • Clearly our ability to make rational trade-offs is completely gone when something reaches the magical price of “free!” • http://www.youtube.com/watch?v=LmJzQ3cVt88

9. Free! drives us crazy • We may opt for a free bank account and spend $6.00 per month on online banking instead of a bank account with a $5.00 monthly fee that provides free online banking • We may pay $10,000 more for a car that comes with free oil changes even though the cost of oil changes over the car’s lifetime may be less than $6,000

10. Free! drives us crazy • We may go to the zoo on a day admission is free even though we’d be much happier going on another day when admission is $15

11. Free! drives us crazy • Barnes and Noble sells a member card with a $50 annual fee that entitles the member to 10% discount • I don’t buy it even though I would save more than $50 annually from the discount • The card would be more popular, I think, if it was free, even if the discount was 3% • Is Barnes and Noble being stupid?

12. Free! drives us crazy • Yes, B&N is indeed being stupid in the sense that we have been discussing • But we will later see that B&N may be relying on other psychological quirks in us • We may buy the card thinking we’ll use it a lot (and, therefore, save a lot of money from the card’s discount) and then not use it much • Or we may buy more books than we normally would; having paid for the card, we’d want to use it

13. Free! drives us crazy • As a policy maker, if you wish people to do X (whatever X is), don’t just reduce the price or fee people must pay to do X, make it free! • X could be taking the flu shot, buying nicotine patches (if you are a smoker), taking online courses, etc.

14. Reading • Predictably Irrational • Chapter 4 The Cost of Social Norms • Chapter 5 The Power of Free Cookie

15. From Market Norms to Social Norms • When something is free, a major change occurs: market norms get replaced by social norms, and we treat each other in ways that are very different from the way buyers and sellers treat each other

16. From Market Norms to Social Norms • People will help you change a tire, if you ask them to do you a favor, but not if you offer to pay them, say, $5.00 • The reason is that when you offer $5.00, you are implicitly sending the message that that’s how much you think the other guy’s time and effort is worth • Standard economics can’t explain this behavior

17. From Market Norms to Social Norms • When the AARP asked lawyers to do legal work for their members for $30 an hour (market norms), they refused • When asked to volunteer their services (social norms) for needy retirees, they overwhelmingly said yes • The law of supply—a fundamental idea in standard economics—can fail under social norms

18. From Market Norms to Social Norms: Productivity • The productivity of experimental subjects at a mundane task was measured • The results show how social norms affect work

19. From Market Norms to Social Norms: Productivity • Businesses can cultivate social norms-based relationships with their employees and suppliers in order to gain an advantage • But then they cannot say “Business is business!” and treat their employees an suppliers harshly when business conditions turn bad • Social norms require two-way shared sacrifice

20. From Market Norms to Social Norms • Norms can also be simulated by priming • Experimental subjects were divided into two random groups • Group 1 Asked to unscramble neutral sentences (e.g., “It is cold outside.”) prior to experiment • Group 2 Asked to unscramble sentences related to money (e.g., “High-paying salary.”) • Then, each subject had to solve a tough puzzle, but could ask for help

21. From Market Norms to Social Norms • The “neutral” group asked for help earlier than the “money” group: • Market norms make people more self-reliant • The “money” group was also less willing to help a stooge who wanted help with the puzzle and another stooge who accidentally spilled a box of pencils • Market norms made people less willing to ask for help and less willing to help

22. From Market Norms to Social Norms—Law of Demand • If somebody brings cookies to the office and offers them for free to those in the office, people will just take one or two • But if cookies are offered for sale by a cookie seller people may buy more cookies • In other words, the law of demand—which says that people buy more when the price falls—breaks down at zero!

23. From Market Norms to Social Norms—Law of Demand • When a limited number of things are offered for free, people become more conscious of their social obligation not to be greedy and exploit the good people who are offering something for free • When prices are not part of the picture, market norms are replaced by social norms; we start caring more about others

24. In a Day Care Center in Israel • The administration—annoyed that parents were showing up late to pick up their kids—decided to make late parents pay fines • Lateness increased! • The late fee induced market norms: “As long as I am paying for being late, I am entitled to keep the teachers waiting.” • The late fee was abandoned • But it was too late. Market norms are sticky!

25. Cap and Trade • Putting a price on pollution makes perfect sense in standard economics • Behavioral economics, however, raises doubts • Once people can excuse their pollution to themselves on the ground that they are paying for the pollution they create, they may pollute more, not less

26. Cash as a birthday gift? • Seinfeld episode: Jerry gives Elaine $182 as a gift on her birthday! • It seems rational … • … but it really is inappropriate • Cash replaces social norms by market norms and ruins the feelings usually evoked by a typical non-cash birthday gift