Today, we look at a different kind of decision, such as purchasing stocks of a company.
How do we decide on buying a chocolate? Mostly, the decision is based on whether the chocolate is good enough for its price. The choice is similar for many other kinds of objects. We are interested in whether the price is worth for the utility we get out of it.
Today, we look at a different kind of decision, such as purchasing stocks of a company. There is no basic utility for holding stocks, unlike a chocolate, which you can eat. So, the decision is based on whether the stock can be sold at a higher price. Basically, you are trying to guess what other people think – would they buy the stock at a higher price later, so you can make a profit by selling to them. Now, how do they decide?
Consider a simple scenario involving three people who are bidding for a resalable product. One of them thinks the product is worth Rs 100, while the other two value it around Rs 45. The first person might start bidding by cautiously quoting Rs 90. This makes the others think it might be actually worth paying more than Rs Rs 45. They might then quote Rs 100, which gets the first person to upgrade to Rs 100. After a few rounds, somebody might buy it at Rs 120. Let us step back now – the final selling price ended up being much higher.
Many buying decisions are made out of a mix of utility and guesses. Bubbles like in our example are often created when speculation builds upon speculation many times over. Be cautious with your speculations, especially when your real utility out of the purchase is low!
(Dr Deepak P. is a computer scientist and academic staff at Queen's University Belfast, UK)