Allocation Through Pricing

Several years ago a friend got me hooked on the annual tradition of buying Beaujaolais Nouveau in November.  This red wine is made from the grapes of this year’s harvest and is shipped out across the world on the third Thursday in November.

It was fun.  For a few years we went together to purchase the wine.  It made for a nice story on Thanksgiving.  And, it was cheap.  I think I recall paying around $5 a bottle for the wine.  But, you had to get there within a day or two or supplies would run out.

Another friend asked me if I bought the Beaujaolais this year?  “No.”  “Why not?”

My first answer was, well it has become too mainstream now.  Everybody knows about it.

Then I thought for a second and continued…

“And, they raised the prices.  At $5/bottle, I’d buy 2 or 3 bottles.  Now the prices are around $10 – $14.  I guess it wasn’t worth it to me.  I have other wines I enjoy more for that price.  Also, I notice you don’t have to get there on day one now, supplies last with the higher pricing.”

I thought back to the story of flashlight pricing at Big Box retailer in Russell Roberts’ The Price of Everything.

After an earthquake, Big Box raised prices.  Of course, that made everyone mad, yet Big Box was the only place in town where you could get what you needed (p. 71).

[Ruth – Econ professor]: “On the night of the big earthquake, there aren’t enough flashlights to go around. At the usual, everyday prices, people want to buy more flashlights than there are flashlights on the shelves, agreed?”

[Ramon – outraged consumer]: “Yes.”

“Given that there aren’t enough flashlights to go around, who should get them?”

“That’s easy.  The people who need them the most.  Not the people who already have one.  Not the people who have lots of candles.  Not the people who are going to sleep most of the night anyway.”

The conversation continued.  Ruth asked how you would decide who needed the flashlights the most.  She points out the problem is knowledge.  You could interview people and see who makes the best case, but Ramon is skeptical that people might not tell the truth.  Ruth adds that along with flashlights you would need to make the same decisions for candles, diapers, portable generators and items to numerous to have any hopes of being effective.

[Ruth]: “If you leave prices alone at their regular everyday levels, who gets the flashlights and the milk and the generators?”

[Ramon]: “The people who need them.”

[Ruth]: “I don’t think so.  If you leave prices alone, the people who get the flashlights are the people who get there first.  When you went to Home Depot, the stuff you wanted was already gone.  But at Big Box, anyone who wanted a flashlight could have one.”

[Ramon]: “If they were willing to pay for it.  That made it harder on the poor people…”

[Ruth]: “Agreed. But for thousands of people, there were flashlights waiting for them.  Remember that knowledge we wanted to have? The knowledge about who needed flashlights the most? When Big Box raises the price of flashlights, someone who had candles at home decided to do without the flashlight and left it there for you on the shelf.  No one had to interview either of you. The higher price induced both of you to act as if you had been interviewed.  The person with the candles, by refusing to buy the flashlight at the higher price, was saying, I’ll pass on buying a flashlight. I’ll leave it for someone who needs it more. But no one begged him to do the right thing or passed a law that would have to be enforced or interviewed him to find out who needed it the most.  The higher price made sure you got the flashlight, that seems pretty just to me.”

With the higher price on Beaujaolais, I decided to pass on it and leave the 2 to 3 bottles I would have bought on the shelf for someone else who valued it more.  I would make due with other wines and without the stories of drinking this year’s harvest.

If you’re still curious about poor people not being able to afford flashlights and would like to know more about what Ruth Lieber says, I encourage you to get a hold of Roberts’ book and read it.

As for me, I’m thinking about buying extra flashlights, batteries and a generator while the prices are reasonable.

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