Consumer surplus is what you make of it

Will Wilkinson doesn't like haggling:

I hate it. I am terrible at it. As a consequence, I bought nothing in Turkey other than tickets to various things, room, food, and a poster of Ataturk. And I overpaid for all of these things, I’m sure, which has left me a bit bitter about the place. Surely this is inefficient overall, no? I understand the price discrimination argument for haggling, especially in a country with a lot of poverty and tourism. But probably hundreds of my dollars stayed in my pocket because I didn’t have good information about the quality of products and I knew the retailer is better at bargaining over the surplus than I am, so… there was no transaction and no surplus.

I can't help but hear the voice of Tyler Cowen echoing in my head:

It is you people, you who resent Coase (1972), you people who induce wage and price stickiness and widen the Okun gap. You people, who don't know what it means to sit back and enjoy your consumer surplus. You beasts!

I weep for Will's missed opportunity. I too have haggled in Turkey, and I have a feeling I'm pretty bad at it. I bought a rug that I am sure could have been obtained for less money if I were a sharper dealer. Who cares? The rug was good wool, had tight knots at the back, and I really liked the design. The important thing was not what it was worth to a Turk; it's what it was worth to me. Which is, a lot more than I paid for it. Most of what is bought in Turkey by tourists is cheap clothing and decorative goods that can be readily visually inspected.

It is only right and natural that we should want to maximize our consumer surplus. But as long as you are getting consumer surplus, you should make the deal. Besides, "one price" is no guarantee that you are getting a good deal. It saves time and lets you free ride on the judgement of others, but Consumer Reports, and America's livingrooms, are full of evidence that their judgement isn't always particularly good.

To be sure, I should not have bought a beige rug. But I still love it. And I'm still wearing the earrings I bought in Greece despite the fact that I know nothing about gold jewelry.

Comments

This reminds me of those experiments where one person is asked to split a dollar between herself and another person, while the other person must approve the split, or they both get nothing. Most people will reject unfair splits, even though they would be better off by accepting the $.05 and letting the other person keep the $.95.

It sounds like Will is saying that he thinks the Turkish merchant is making an unfair split of the consumer surplus, and thus he punishes the Turk by refusing to buy, even though buying would make him better off.

But maybe this is rational over the long run? If enough tourists act like Will does, this might incentivize the Turks into making the transaction more transparent, so that Will and others in future will receive fair splits of the surplus. At least this is the explanation frequently given for the experiment results mentioned above. People punish others for unfair splits because they expect to play the same game with the same people multiple times.

Posted by Rob | May 13, 2008 4:26 PM

Well, the problem (of course) is that haggling discriminates against those of us who believe politeness is a virtue, or who are insecure, or who have social anxieties. The reality of haggling is far removed from the behaviors of homo economicus.

I'm with Will on this one. I feel bad when I walk away from a haggled transaction. Did I get the best price for me? Did I give a fair price for the seller? Am I happy with the item at that price? There's no sense of satisfaction.

Posted by Grunthos | May 13, 2008 4:28 PM

I watched one of those shows on cable where a woman travels the world eating things I wouldn't. She was shopping while in some central asian country. A merchant who knew a little English tried to sell her something "200,000!" of some currency, he shouted. She waved him off, "Seven!" he offered. How the hell do you shop where people cut their asking price from 200,000 to 7 in one breath?

Posted by Njorl | May 13, 2008 4:32 PM

Q: How was copper wire invented?

A: Someone dropped a penny between a Chinese merchant and his customer.

Posted by secret asian man | May 13, 2008 4:45 PM

I'm not a huge fan of haggling either -- like most Americans, car shopping is the only time I engage in it. (On my own behalf. I negotiate deals for clients all the time.) But the bottom line (no pun intended) is the one Megan states: focus not on whether you could have done better, but rather on whether you did good enough. If you would have been satisfied to pay that price if it had been pre-printed on a price tag, then be happy.

Posted by David Nieporent | May 13, 2008 4:48 PM

Rob,
Good comparison.
However tourist shopping is a series of independent one time games. When Will punishes the shopper for an unfair split he does so either irrationally or because he is an altruist who cares more about other tourists than himself. It is unlikely and empirically incorrect to assume that other tourists have this same preference, otherwise the tourist market would be radically different.

I have a feeling that Will is the sort of guy who would refuse to make a deal in the prisoners dilemma. Sure if everyone has this backwards and unusual preference then the dominant strategy will change but there is no sign of this ever occurring.

Posted by Gordon Gekko | May 13, 2008 5:05 PM

The proper emotional stance toward haggling while traveling is made more difficult when you're in the situation of trying to financially muscle some poor guy who doesn't have much money. This situation also requires you to jeez, let him win, just get a bargain for yourself. When in Saigon several years ago, the people were so heartbreakingly poor that even though they expected to haggle, I still couldn't bear ratcheting down the prices as much as possible. So we'd play out this little theater-of-the-absurd where he starts at $25, I get him down to $12, and then give him $20 anyway.

Megan, I have found rug prices worldwide offer relatively little in the way of arbitrage, but having said that, Turkey is one of the best places to get a deal.

Posted by Eriver | May 13, 2008 5:05 PM

Exactly. You're executing a rational economic transaction, but the medium is a strongly social mechanism, which gums up the works.

Posted by Grunthos | May 13, 2008 5:23 PM

Megan, Here is what I wrote in response to a similar comment at my blog....

First, and obviously, for about any good, I prefer not to pay much more than the lowest price on the market (taking into account search costs, etc), because that leaves me with less with which to buy other things. People are not being stupid when they are nonplussed to find the same pants they just bought for half the price at another store. That’s a real loss. Second, in the particular case of haggling in Turkey, there is an extreme information asymmetry. There is no assurance about the quality of goods. Most branded goods are counterfeit, so one can’t use brand reputation as a proxy for quality. And there is no way of telling if they are just lying to you about the nature of goods. So you don’t know what it’s worth to you because you don’t know what it really is. For example, Kerry found an allegedly silver bracelet she liked, but we didn’t know how to tell whether it was really silver, or the quality of silver advertised, etc.

I think it’s weird to think you can just look at an item and then magically intuit your reservation price.

Posted by Will Wilkinson | May 13, 2008 5:23 PM

Wilkinson's comments aren't irrational.

1) Opportunity cost: Will can spend his hard earned money in some other market, like internet purchases of fungible goods, or Wal-Mart, where he knows he is likely to get a better deal. It is true, of course, that if buying a rug in Turkey for $500 has more consumer surplus for Will than buying a bicycle from Amazon for $500, then Will should buy the rug, regardless of how much surplus the Turkish merchant captures. Still, Will had better be pretty confident of his expected surplus, because of:

2) Information inequality: The absolute win for the Turkish merchant is to push Will's share of the surplus into the negative region, ideally far far into the negative region. Will knows he is dealing with someone who has an unequal knowledge of the quality of the good, and is using the technique of haggling to cheat him.

If the guy charges the same price to everyone, then Will, who is otherwise an easy mark, comes out ahead, because he pays the market clearing price. If the guy charges everyone a different price, then very savvy shoppers pay close to the marginal price, but people like Will pay much more than he has to.

Posted by J Mann | May 13, 2008 5:27 PM

"I have a feeling that Will is the sort of guy who would refuse to make a deal in the prisoners dilemma. Sure if everyone has this backwards and unusual preference then the dominant strategy will change but there is no sign of this ever occurring."

If, in the limit, social norms push people toward being unconditional cooperators, then PD's don't arise. Cooperation becomes the dominant strategy. And this is what we want. My sense is that I find haggling SO uncomfortable in part because I do come from a culture (American/Upper Midwestern/Anglo-Germanic-Nordic) that approximates a norm of unconditional cooperation about as well as anywhere. When your strategic-emotional repertoire is strongly geared toward trust, strong reciprocity, and conciliation, the stark conflict of haggling almost seems like a kind of violence.

Anyway, I was glad to have a layover in Vienna, since Austria is kind of like an anti-Turkey. And I don't think it is an accident, or irrelevant to the discussion about haggling and surplus, that Vienna is, in comparison to Istanbul, ridiculously wealthy.

Posted by Will Wilkinson | May 13, 2008 5:42 PM

Speaking only for myself, one reason I don't like buying things in a foreign land (like Turkey or NYC) is I don't like feeling I've been a fool nor do I like not knowing whether I'm acting foolishly. It's purely an emotional thing. I don't like the uncomfortable feeling involved in negotiating so I don't do it. I'm more than willing to forgo a deal to avoid that feeling.

Two quick examples: When I was living in Naples, a shop owner I knew offered to sell me a cameo for a good price -- $25 IIRC. While I was examining the broach, in came some US sailors. The shop keeper told me, in Italian, to be silent or he'd never allow me back in his shop. One of the sailors bought "my" cameo for just over $200 -- almost ten times what I would have paid for it. The sailor left thinking he'd gotten a good deal. (At the start of negotiations, the shop keeper told him the price was $350.) After the sailors left, the shop owner laughed at them. I just don't want to be laughed at.

Two years ago I was in NYC for a week-long conference. I forgot my laptop's power supply and went across the street to an electronics store (one of several in the Times Square area). They wanted $175 for a power supply. The price fell to $115 by the time I was out the door. My company would have reimbursed me for the $175. I had my own power supply FedEx'd to me, instead.

Posted by David Walser | May 13, 2008 5:49 PM

I find that my attitude -- my mores -- change in the third world. In the USA (or New Zealand or ...) I would bargain or carefully price compare, depending on the culture. But if I am in La Paz negotiating for a taxi ride or some wool? Compared to anyone in the USA, these people are poor. Moving a small amount of surplus from me to them is not a wash -- it is a gain of utility. Call it "shopping combined with charitably aiding third-world entrepreneurs".

Posted by Robert Ayers | May 13, 2008 5:53 PM

But that's not a characteristic of haggling; it's a characteristic of stores in tourist areas with lax regulation. Unless you shop at Zales, etc., you're pretty much relying on the goodwill of the merchant not to sell you crap, and you're likely to be overcharged relative to someone who can identify sterling silver or 18K gold at a glance. Many jewelry stores between the bargain basement chains and Tiffany's haggle.

Likewise, your very example illustrates that one price is no guarantee of maximizing consumer surplus. When I go to London I have no idea whether the pants I like in one shop are available in another shop at half the price, and having lived in New York and London, I can testify that they very probably are. Since I am probably not going to find that price as a tourist: buy the pants I like at a price I am willing to pay, or decide that I don't like the price and walk away.

The fear of being a stupid tourist--of paying more than the locals pay--prevents far too many deals from going through. I understand that there are other information problems that should keep you from buying, but worries that you aren't getting enough consumer surplus shouldn't be among them.

Posted by Megan McArdle | May 13, 2008 6:04 PM

The fear of being a stupid tourist--of paying more than the locals pay--prevents far too many deals from going through.

It seems to me this is more of a problem for the poor locals than the rich tourists. Which suggests that if those locals are really interested in capturing some surplus, they should consider changing their pricing policies. Or at least stop considering the right to laugh at people a part of their own personal surplus.

Posted by Rob Lyman | May 13, 2008 6:35 PM

This is somewhat off-topic:

"I think it’s weird to think you can just look at an item and then magically intuit your reservation price."

I'm glad to hear you say that, since I do research on the use of auctions for initial public offerings. The basis for the common (among financial journalists, anyway) idea that auctions should price IPO shares accurately is the idea that everyone will bid 'whatever the shares are worth to them', and thus the auction bids will reveal the 'true demand curve'. One big flaw is the assumption that people can simply hear the name of a stock and instantly know exactly how much they're willing to pay for it.

If you can't look at a bracelet or rug and know how much you're willing to pay, how are you supposed to instantly know this for a claim to a highly uncertain stream of future revenues?

Posted by Ann | May 13, 2008 6:36 PM

When I lived in Hong Kong, I never liked bargaining but eventually got used to it. I found that simply smiling and asking "best price?" would take at least 10% off pretty quickly, and it let me save face so that they were less likely to laugh at me as I left, even though I didn't drive a hard bargain.

Traveling in places like Thailand, when male foreigners would bargain heavily with the female locals, the women would just giggle and say "come on, mister, it's only 10 baht". That usually made them ashamed to try to wring the last penny out of people that had so little.

Posted by Ann | May 13, 2008 6:48 PM

Second, in the particular case of haggling in Turkey, there is an extreme information asymmetry. There is no assurance about the quality of goods. Most branded goods are counterfeit, so one can’t use brand reputation as a proxy for quality. And there is no way of telling if they are just lying to you about the nature of goods. So you don’t know what it’s worth to you because you don’t know what it really is. For example, Kerry found an allegedly silver bracelet she liked, but we didn’t know how to tell whether it was really silver, or the quality of silver advertised, etc.

I don't understand what the existence of haggling has to do with there being no assurance about the quality of the goods. If the price was set in stone, you still wouldn't be assured of the quality of the goods.

In the end, my feeling is similar to Robert Ayers and others - to the extent that you are paying a price higher than you would in the absence of haggling, consider the delta to be charity. The folks from whom I bought jewelry in Pakistan derive a lot more utility than I from the extra $X I paid for it compared with some theoretical "fair" price.

Posted by Al | May 13, 2008 7:01 PM

I'm surprised no one has mentioned another social aspect of haggling in poor countries for tourist goods, which is that once you engage the seller it can be quite awkward and difficult to disengage without making a purchase. At least for me, this is often a deterrent from even asking about the price of something. This of course has nothing to do with consumer surplus, but is just another way the shopping process can turn off potential customers. Count me among those who doesn't like haggling not just because of the uncertainties of ending up with a "reasonable" price but because I really don't enjoy haggling.

Posted by daffy duck | May 13, 2008 7:32 PM

Megan,

I don't disagree with you. I shouldn't let my emotions rule and I should be willing to pay the price a half-hearted negotiation yields. Under some circumstances, I do just that. Say I'm in Tiajuana and am hungry, I'll negotiate with the taco vendor -- but I have to be really hungry.

Some people enjoy the game of negotiating. I don't. I'm very competitive, driven more by a desire not to lose than to win. Negotiating is a game where I'll never learn the "score" and I'll always assume I lost. Under those circumstances, I'd rather not play. On the other hand, if you and I were shopping together, I wouldn't mind engaging in some friendly competition to see who could get the best deals. (Even if we weren't buying the same items, half the fun would be arguing about who won.) But, if I'm just buying something for myself, I'm playing against the house and I'm pretty sure that's a game I'll lose.

Posted by David Walser | May 13, 2008 7:35 PM

But . . . GAINS FROM TRADE!!!! If you like it more than whatever you would have bought with the money you spent, then you both win. You only lose if you think of it as a contest rather than a mutual exchange.

Posted by Megan McArdle | May 13, 2008 8:02 PM

You only lose if you think of it as a contest rather than a mutual exchange.

Hey, somebody should tell that to the locals who snicker about the dumb tourists and thereby discourage trade.

Posted by Rob Lyman | May 13, 2008 8:05 PM

As a traveler, I sometimes like haggling. It's sort of fun for me to argue with someone over the price; the give and take of each of you trying to get the best part of a bargain is at times compelling and fun.

What annoys the hell out of me isn't haggling for normal stuff like fake bags and polo shirts, it's for things like taxis and hotels. After a long train or bus ride, the last thing I feel like doing is debating over the price of a double room at a guesthouse.

Posted by Chris | May 13, 2008 9:29 PM

I like haggling, but you have to be willing to walk away if you are unhappy with the price. This is where a lot of people, who hate haggling, end up feeling they got taken- they pay a price they are unhappy with rather than pass on the deal.

As for the relative financial status of the two parties, there is something to be said for the charitable aspect of it all, but the disparity has to be quite significant for me to consider paying more than I think I could get with further nogiation.

Posted by Yancey Ward | May 13, 2008 10:23 PM

"The folks from whom I bought jewelry in Pakistan derive a lot more utility than I from the extra $X I paid for it compared with some theoretical "fair" price."

But this isn't a useful guide at all. By the same reasoning, shouldn't you just give them the money and not take the item? Shouldn't you max out your credit cards and hand out every dollar you can raise to whoever you happen to pass by? If I haggle a bit, I still end up paying a price that the original sellers are happy with, and I have money left to spread the happiness around to even more sellers.

I agree with daffy duck that haggling simply makes the whole process time-consuming and uncomfortable. You can't look over a whole shelf of items, weighing their attractiveness against their price, in order to find the one with the greatest net benefit. Instead, you have to make your choice without knowing even the approximate relative prices, then begin the long negotiation process, being willing to walk away if necessary. It's clearly not the most efficient process from the standpoint of search costs, because of the high cost of simply learning the prices of all of the goods.

Posted by Ann | May 13, 2008 11:32 PM

I find it fascinating that this is a discussion about purchases in foreign lands (i.e. Turkey). Look, certainly in my county (Canada), and in yours, just about everything is negotiable. It's not just cars!

You just don't engage.

Seriously. You, and Will, could be getting a better deal on nearly everything you buy if you try to haggle. The information asymmetry problem exists here too, but you can look things up on the web to try and get a better deal.

Go into any electronics shop and you can negotiate a deal. Just ask for the best price, and work from there, but be prepared to walk away.

Other things are negotiable as well. I've successfully negotiated card holder terms with VISA.

Posted by Ginna | May 14, 2008 2:16 AM

GAINS FROM TRADE!!!! If you like it more than whatever you would have bought with the money you spent, then you both win. You only lose if you think of it as a contest rather than a mutual exchange. - Megan

Yeah, to a point, but this isn't a transaction that takes place just once. It takes place dozens of times on every trip. Weak behavior doesn't just invite aggression, it tempts you to start thinkig of yourself as weak, or establishes a pattern of behavior in your own head. Part of what you're doing by haggling hard is steeling yourself for subsequent haggles. It's like shooting smack -- accept that high price once because it's still worth it to you, and it's no biggie, but if you start letting yourself give in to people, you're going to find yourself at the end of your trip $500 poorer than you might have been, and thus unable to afford that really nice rug that's so much nicer than the other thousand virtually identical rugs hanging right next to it.

But I completely agree that worrying RETROSPECTIVELY about whether you paid too much for something is totally useless. Fight the fight, then move on and never think about it again.

Posted by brooksfoe | May 14, 2008 7:51 AM

It was a special rug! Handmade by rural villagers in a beautiful sustainable co-op by the sea! :)

Posted by Megan McArdle | May 14, 2008 8:33 AM

Megan already beat me to the point that information asymmetry is a separate issue from haggling. You could get ripped off by phony products in a big box store called Turk Buy with shelves and price tags just as easily as you could in the street with haggling merchants.

But I do agree with Will that the haggling constitutes high transaction costs, and will likely correlate with a poorer economy. I also sympathize with his social tendencies, as I share them, especially the statement "When your strategic-emotional repertoire is strongly geared toward trust, strong reciprocity, and conciliation, the stark conflict of haggling almost seems like a kind of violence."

But to say "this feels bad to me with my personality" is hardly the same as "this is objectively negative behavior." If we're right about the haggling transaction costs and the chilling effect they have, then the winning strategy is for a couple of Turkish merchants to put up big signs that say "No haggling! Fair prices!" and win a lot of business. Carmax is even doing this with car sales, and has proven appealing to many. However, there might be cultural hurdles that prevent this amongst Turkish merchants...

Posted by Geoff | May 14, 2008 10:01 AM

"It was a special rug! Handmade by rural villagers in a beautiful sustainable co-op by the sea! :)"
Posted by Megan Mc

Chock full of carbon sequestered directly from the atmosphere no doubt.

Posted by Njorl | May 14, 2008 2:36 PM

Geoff writes: "Megan already beat me to the point that information asymmetry is a separate issue from haggling. You could get ripped off by phony products in a big box store called Turk Buy with shelves and price tags just as easily as you could in the street with haggling merchants."

I disagree - the two issues are linked. At the highest level of abstraction, knowing that the store sells at the posted price gives me a useful piece of information that reduces the information asymmetry. More specificially:

1) A big box store that usually sells products at its market price lets me free ride on the knowledge of other more knowledgeable purchasers. If the store is patronized by, say, locals, and if I am paying the same price as the locals, that tells me something important I didn't know before about the likelihood that I am getting ripped off.

2) As mentioned upthread, stores that typically sell at their posted price also let me price compare without exorbitant search costs. If it takes me 30 minutes to find the actual price of any given rug at a Turkish market, then there will be less price competition between merchants than if I can find the price from any given merchant in about 30 seconds. The knowledge of what this merchant is charging *relative to other merchants* is a key information asymmetry that is largely addressed through uniform pricing.

Posted by J Mann | May 14, 2008 3:12 PM