Lessons in the Free Market: Bad Business Incentives

There are some aspects of the free market that some people do not have faith in. They believe that in certain dealing that the business is not interested in making them happy and that they are only interested in a profit. This is the classic explanation of greed. The shoe salesman should not try to sell you the most expensive product but the one that fits you.

I had a friend at Best Buy for example that was told to tell customers that he does not work on commission. This is suppose to give the customer hope that they will be treated as a human and not as a dollar sign. The truth is that businesses always try to look out in your interest. They are there for that purpose. Best Buy knows that Circuit City is across the street and that they sell the same T.V. There is a reason you chose one over the other. It could have been location, or the fact that you know they have deal that the other one doesn’t.

People are growing up in an ever changing economy. They no longer have their local bank with their local grocery and there local et cetera. Local, local, local made people feel like they would never be cheated. How could the kid you knew that grew up down the street sell you wrong? You must look at incentives.

I would argue that the kid down the street that grew up to own his own tobacco shop has more of an advantage over you then you do with a corporate international one. First, you are under a false security blanket. Second, he is not taking advantage of economies of scale and when he is faced with tough competition he will do anything to get you to buy something. Lastly, which is that they have a monopoly on you.

People are constantly scared of monopolies but when you patronize your local shop and pay their higher prices to “keep them in business.” You, in fact, are monopolizing your purchases. This is not unlike the Wal-Mart versus little shop examples you hear all the time. If a corporation can come in and offer you the same product for a much cheaper price then take it. There is a reason why they can do it.

Every business is in business to sell things. If you believe you are getting ripped off then you will not purchase anything and thus they will go out of business. This example may be crazy and out there to most people but it should be used to apply to all business transactions:

Barbers get paid to cut hair. It is in their best interest to sit you down spray some water in your eyes and make scissor noises until you pay. Let’s assume he sprays the water in your eyes well and you still do not notice and you pay for this “hair-cut.” As soon as you go home, you realized what is up and now you must get your hair cut again. This the plan of the Barber, except are you going to go to the same Barber? No, you are going to patronize another place and if they do it right you will create loyalty. The first Barber has now helped his competition and possibly put himself out of business.

So next time you hear someone say something like this, you know that it is their lack of faith in the market and not the lack of the market. The classic example that makes me mad is when someone says Doctors do not have an incentive to find a cure for cancer. If you can apply the haircut situation to this, then you have mastered an important lesson in the free market.


Published in: on December 21, 2008 at 1:00 pm  Comments (1)  
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