Tuesday, March 1, 2011

(Ir)rational Economics: the placebo effect and wine prices

So far 2011 has been an excellent year for wine market news. The IMF found the price of fine wine tracks almost exactly with the price of oil. The correlation is so perfect (90%) that it would defy logic unless the same factor is influencing both. And it is. According to the study "aggregate demand growth, especially in emerging markets, is the most decisive factor in determining crude oil and fine wine prices."

So, in short, as developing countries get richer, they demand more and better wine. (Makes sense, as I have progressed in my career and made more money, I have demanded more and better wine, too!)

But what about the price range within the wine market?
What makes one wine expensive, and one cheap, in the first place? Or more importantly, is there really a difference between a $9 bottle and a $90 one?

Clearly there is a market for high-priced wines. I once witnessed a Japanese tourist paying $6,000 (plus shipping, taxes, and fees) for a handful of bottles at Opus One, and that wasn't even considered terribly expensive by wine-collector standards.

So does price matter?

Slate's author Coco Krumme did some research to try to answer that question. What Krumme found is that fancy words are strongly associated with high-priced bottles of wine, and "cheap" words with inexpensive ones.

But is that because the expensive wines are actually better? Or because we think they should be better? Don't get me wrong, I do believe there is good wine and not-so-good wine in the world. But can we tell the difference between a decent bottle and an exclusive one? Research suggests that we cannot...

In the Power of Price chapter in Predictably Irrational, Dan Ariely describes is that there is a strong placebo effect of price on our perceptions. If something is more expensive, we expect it to taste better, work better, and to be of higher quality.

And apparently when we know the price, we think that higher-priced wines are better, even when the wine we're tasting is a $9 bottle with a $90 price tag slapped on (based on research from A. Rangel at Caltech).

So the moral of this story is: drink wine you like, especially if you can get it cheap. Just remember to remove the price tag before you serve it to your guests.

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