When we set the price of a Lindt truffle at 15 cents and a Kiss at one cent, we were not surprised to find that our customers acted with a good deal of rationality: they compared the price and quality of the Kiss with the price and quality of the the truffle, and then made their choice: About 73 percent of them chose the truffle and 27 percent chose a Kiss.
Now we decided to see how FREE! might change the situation. So we offered the Lindt truffle for 14 cents and the Kisses free…
But what a difference FREE! made. The humble Hershey’s Kiss became a big favorite. Some 69 percent of our customers (up from 27 percent before) chose the FREE! Kiss, giving up the opportunity to get the LIndt truffle for a very good price.
That is from Dan Ariely’s new and excellent Predictably Irrational: The Hidden Forces that Shape Our Decisions. Here is Dan’s book-related blog. All of a sudden my head is spinning, wondering what a relative price ratio really means (we can’t divide by zero). Or is this just the Alchian and Allen theorem on steroids, namely the claim that fixed charges encourage the consumption of the higher quality good? Or I think: "Zero, is there something special about that number?"
There is more on the way in behavioral economics. There is Sway: The Irresistible Pull of Irrational Behavior, by Ori and Rom Brafman and Nudge: Improving Decisions About Health, Wealth and Happiness, the defense of voluntary paternalism from Richard Thaler and Cass Sunstein, due out later this June and April respectively.