Pareto improvements: a cautionary tale

I heard this week of a friend who was writing a paper on supermarket pricing.  Some of the research that the shop had carried out (which, unfortunately, remains confidential) showed that people were, at times, put off buying items if they were in a buy-one-get-one-free deal.  Indeed, there were a few items that actually sold worse when they were in a deal than when they were out of it, particularly when you looked at individual shopping habits – yes, those Clubcards are pretty useful from a econometrics point of view.

Why would this be?  There’s an economic principle of a Pareto improvement, which describes a situation where a consumer is better off in one way while all other measures of welfare or utility are as good (or better) as they were previously.  If a consumer were getting the same basket of goods for the same price, but with one extra (say) box of cereals, then surely this is a definite improvement?

The trick in this case is to think a little less like an economist.  The person may own more, but the added goods may actually decrease utility.  They may feel guilty for having cereal that may well get thrown away.  They may feel stressed about having to find somewhere to store it.  They may find it a hassle to have to carry an extra box to the car.

In that case, why not simply buy only one box and ignore the offer?  People have been observed to consider things as being less valuable if they are not taking up an offer – that is, they may suddenly think that a box of cornflakes is not worth £1.50 if you can buy two boxes for the same amount.  Similar research has seen that consumers consider buying two items at half price to be a different proposition to buy-one-get-one-free.

In short, consumers are not rational.  When economists start many theories by assuming they are, we can find ourselves coming unstuck.

One Reply to “Pareto improvements: a cautionary tale”

  1. I believe the concept of rationality has been abused, and apparently continuous to be abused, in the econoomic arts like no other. In (neo-)classical economics the abuse was in the assumption of rationality and in newer forms of economics in the denial of it. Rationality is much more complex and it be better left to philosophers and psychologists to determine who and what is rational. Rationality is not the issue in economics anyhow, so economists better don’t use is, and stick to concepts that are properly within the realm of economics.

Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.