The Economics of Ransoms

Here’s something that the econ model tells us shouldn’t matter: the going rate. In normal markets the going rate matters, but only because it provides the opportunities for substitutes and this creates the “law of one price.” For instance, when I go to a grocery store and see a loaf of bread for $4 I won’t buy it. An economist would say I forgo this purchase because I know perfectly well that the going rate for a loaf of bread is about $2.25 and so I can go elsewhere and get bread cheaper. Similarly if I go to the Honda dealer to buy a Honda Accord, it is relevant for me to mention price quotes offered by other Honda dealers for an Accord or even how much Toyota dealers ask for a Camry because it is entirely credible that I’ll walk off the lot and go to rival car dealers offering very close substitutes for this dealer’s cars. However if my sister is locked in a basement in Ciudad Juarez and the kidnappers can credibly commit to not letting her go unless I raise $x, it is completely irrelevant that in the past kidnappers accepted ransoms of $x/2 since I don’t have the relatively good fortune of dealing with a kidnapper who demands $x/2 but am stuck with one who demands $x. There are no other places where I can buy the freedom of my sister and so the only price that matters is the one being demanded by her particular kidnappers. (Note to any cartels reading this: I don’t have a sister).

Megan McArdle has a terrific piece about ransom negotiation in The Atlantic. If you are the hostage, keep your mouth shut until you’re saved.

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