Tuesday, 18 July 2017

Caramilk arbitrage and the endowment effect

As 1974 Nobel Prize winner Friedrich Hayek noted, markets allocate goods to the buyers who value them the most, since those are the buyers who are willing to pay the most for them. So, consumers who purchase the good at a low price, may be willing to give up their purchase in exchange for more money from those who value the good more.

Having said that though, the endowment effect doesn't make Hayek's observation automatic. Quasi-rational decision makers are loss averse - we value losses much more than otherwise-equivalent gains. That makes us are unwilling to give up something that we already have, or in other words we require more in compensation to give it up than what we would have been willing to pay to obtain it in the first place. So if we buy something for $10 that we were willing to pay $20 for, we may choose not to re-sell it even if someone offers us $30 for it.

We've seen a graphic example of both of these effects (goods flowing to the buyers who value them the most, and endowment effects) this week, as Newshub reports:
Ever since Cadbury relaunched its iconic Caramilk chocolate in New Zealand last month, our Aussie neighbours have been desperate to get in on the action.  
The chocolate, a solid bar which is a blend of caramelised white chocolate, was a '90s classic, and appeared back on supermarket shelves around New Zealand at the end of June. The limited edition product is a New Zealand-only release and isn't available in Australia.
Now some clever Kiwis have cottoned on to the demand across the ditch and are putting Caramilk blocks on Ebay Australia for Aussies to buy.
And it turns out they're willing to pay quite a bit.
One auction, which closed early on Monday afternoon (NZ time), saw 19 bids for one $3 block, which eventually sold for AU$40 (NZ$42.64). release and isn't available in Australia.
Savvy New Zealand chocolate buyers have been snapping up Caramilk chocolate for a low price in New Zealand, and promptly on-selling the bars to Australians for a higher price (this practice of buying in a low price market and re-selling in a high price market is known as arbitrage). However, in order to overcome the endowment effect, the price must be high enough to induce them to sell and overcome the endowment effect. But NZ$42 can buy a lot of alternative chocolate!

Eventually though, greater quantities of Caramilk being offered to Australians will leave only those Australians with lower willingness-to-pay for it unsatisfied, and the auction prices will fall. Once the buyers who are willing to pay $42 have their chocolate, that only leaves buyers willing to pay $40, and once they've got their chocolate that only leaves buyers willing to pay $38, and so on. So if you're thinking of trying to take advantage of this arbitrage opportunity, you'd better get in fast.

[HT: Memphis from my ECON100 class]

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