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Tuesday, December 12, 2006

The Value of a Free Lunch

From the Kristina Shampan’er and Dan Ariely of the Boston Fed:

How Small is Zero Price? The True Value of Free Products, WP 06-16 by Kristina Shampan’er and Dan Ariely, FRB Boston: Abstract When faced with a choice of selecting one of several available products (or possibly buying nothing), a standard theoretical perspective suggests that the option with the highest benefit-cost difference will be chosen. This analysis applies to all prices including the price of zero. In contrast, we propose that decisions about free products are different than simply subtracting costs from benefits, and that in fact the benefits associated with free products are perceived to be higher. We test this idea by contrasting the demands for two products (types of chocolate) across conditions that maintain the cost-benefit difference for the goods, but vary on whether the price of the cheaper good in the set is priced at a low positive price or at zero. Contrary to a standard cost -benefit perspective, the results show that, in the zero-price condition, the proportion of participants choosing the less attractive chocolate dramatically increases, while the proportion of participants choosing the more attractive chocolate dramatically decreases. Thus, individuals seem to act as if pricing a good as free not only decreases its cost, but also adds to its benefits. After documenting this basic effect, we propose and test several possible psychological antecedents of the effect: Social norms, Mapping difficulty, and Affect. The results suggest Affect as the most likely source of the effect.

    Posted by on Tuesday, December 12, 2006 at 02:34 PM in Academic Papers, Economics | Permalink  TrackBack (0)  Comments (9)


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