Sausages, hot dogs and Rolls Royces

Posted on December 17, 2013 | in Confessions of a Serial Entrepreneur | by Richard

Kids just don’t know how to say “thank you”. As a child who grew up in a foster home, I was very lucky to have had some wonderful schoolteachers who looked out for me and made getting an education enjoyable. When I finished high school at 17 though, I just walked out of the school yard one last time without as much a “good-bye”, let alone expressing any gratitude. Years later I looked back on that and felt truly awful; I just hoped my gross selfishness didn’t at all impact on those teachers’ enthusiasm and willingness to give time to students who followed me. So I was thrilled when one of my favourite teachers, Peter Rolfe, contacted me on his way through London and I could treat him to dinner at a good restaurant. It was over 30 years since I’d seen Peter and hearing about the rest of his teaching career reminded me that some people have that wonderful ability to just keep giving, no matter what they get back. And I was able to remind him that it was he who had ingrained my lifetime love of economics.

Whoever said economics is the “dismal science” was wickedly wrong. Economics draws from many fields; it’s like a melting pot for things like psychology, logic, the scientific method, statistics, and mathematics. That’s why it can be so fascinating. This week and next, I want to mention a few that Peter used to ignite my imagination.

Giffen Goods. Normally if something goes up in price, people buy less. Giffen goods however, behave in a strange way. They sell more because they are expensive. The example Peter gave was Rolls Royce cars, which like other luxury goods give the buyer prestige as well as a product. And the reverse can be true when Giffen goods don’t sell despite their low price. I was reminded of this when I tried, but basically failed, to sell high-quality cheap tennis racquets on line. People assumed they were rubbish even though they were every bit as good as the expensive models.

Hotelier’s theorem. On a one-mile beach packed with sunbathers, there are two competing hot dog stands. Where’s the best place for them to be positioned? Answer: a quarter of a mile from each end. That way the maximum any buyer has to walk, either from near the middle or near an end, is a quarter mile. The trouble is, the businesses will move towards the middle, almost to the point where they are both positioned next to each other, and some unlucky sunbathers will have to walk nearly half a mile. The hot dog sellers know that on each side of them there is a “captive market” who have no choice – the competition is even further away. Now, we see this movement to the middle all the time. Areas of competition start out offering a real choice but end up being very similar. Politic parties, for example, used to offer a choice between near socialism or elitist capitalism; now the parties are all basically in the middle offering market oriented policies with a social conscience. Consumer products also converge; look at PC’s or printers and try to find any real differences. It makes me wonder how similar the iPhone and Samsung Galaxy will be in a few years time.

Substitution. When incomes go up, people buy more sausages, because they can afford to. But they also buy less sausages, if they substitute-in more expensive meats such as steaks. Whether the “income effect” or “substitution effect” dominates will determine whether sausage sales rise or fall.

Sausages, hot dogs and Rolls Royces. There was a lot to reminisce with Peter about. More next week.