We are not as rational as we think we are when we shop. Dan Ariely introduces the concepts of relativity and effective pricing, and how these influence our purchasing habits.
Economics is the study of how humanity deals with scarcity.
Scarcity simply refers to the state of having limited resources.
Tangible resources like money, food, clothing don't fall from trees! Your net worth is limited by your income, life savings, and inheritance, at least for the lucky ones.
Intangible resources like time and effort are also bound by human capacity.
We can't do everything we want at the same time. In order to do one task, we would need to put the others on hold, or relay it to someone else.
To rephrase, economics is the study of how we share and compete on limited resources. The field has the following assumptions:
First assumption: People make rational choices.
In other words, traditional economists assume that people would weigh first the possible gains and losses in a calculated way before making a decision.
Hmmm, I wonder: do we actually conduct cost-benefit analysis in our heads for all our decisions? Don't we all use instinct, or gut feel sometimes?
Moreover, I started to wonder why I often put off exercising—despite its health benefits.
Why people spend lavishly on sneakers, specialty coffee and weekend getaways instead of saving for retirement?
Second Assumption: People act based on their self-interest.
If this is purely true, why do my managers treat us a scrumptious lunch for every milestone, even though we are getting paid to get things done anyway?
And also, why do we love giving our family and friends Christmas gifts?
This is when Behavioral Economics is born: a new field in economics which uses psychology to study how humans make economic decisions.
It borrows the principle from psychology that humans tend to be irrational in their actions and decisions.
Dan Ariely's Predictably Irrational serves as my introductory material to this field. After I completed his Coursera class on Irrational Behavior, I was swayed to grab this book and indulge more on the topic.
For today, I shall discuss how the concepts of relativity and effective pricing can influence our shopping habits.
The first two chapters explains why we often pay more than we think.
Chapter 1. The Truth on Relativity: Decoy Effect
The Illusion of Relativity. If you look closely, the orange circles are of the same size! The first orange circle looked smaller because its adjacent gray circles are larger in size. This is also known as the Ebbinghaus Illusion.1
Akin to the left orange circle, our achievements or possessions become trivial when we surround ourselves with people who have more. This also works on the other way around, as illustrated by the right orange circle.
Most people don’t know what they want until they see it in context.2 Marketers tend to exploit this human tendency by applying the Decoy effect in most of their pricing models.
Case Study: The Economist subscription packages
- Web only: 59 USD
- Print only: 125 USD
- Print and Web: 125 USD
Most people would pick the third option to make most out of their money.
- Web only: 59 USD
- Print and Web: 125 USD
The context becomes different without the Print-only option. Without it, the third option becomes more expensive, in contrast with the Web-only option.
Chapter 2. The Fallacy of Supply and Demand: Anchor, Power of Branding
The price, known as anchor, is said to have a long-term effect on our willingness to pay for a product.
Tom had discovered a great law of human action, namely, that in order to make a man covet a thing, it is only necessary to make the thing difficult to attain. - Mark Twain, The Adventures of Tom Sawyer
The book elaborated on the topic with the following case studies:
Case Study #1: James Assael's Tahitian Black Pearls
Tahitian Pearls. Image Source: National Geographic 3
James Assael had a difficult time selling the Tahitian Black Pearls. After years of failed marketing, he re-introduced the pearls to the market with an hefty price tag. Associating the pearls with precious gems such as diamonds and rubies enticed the Manhattan rich to purchase the pearls.
Case Study #2 - Starbucks
Howard Schultz worked diligently to separate the brand from other coffee shops not through low prices, but through the ambiance 4. Upscale ambiance allowed them to set premium prices.
That's why most people are willing to buy expensive coffee from Starbucks, despite having numerous and cheaper caffeine options.
Case Study #3 - Experiment with Social Security Numbers
In one experiment, Ariely asked students to write the last two digits of their Social Security Number. Then, he asked them to bid the prices for some products.
Students were unconsciously using their Social Security as anchors to their bids. Students with Social Security number ending in the upper 20% placed bids that were 216-346 percent higher than the rest.4
In other words, you're more likely to bid a higher price if Social Security number ends with "99", rather than with "19" or "59".
In a nutshell, we tend to make unwise shopping choices because of the following traps:
- Decoy Effect
- Pricing Anchors (or Arbitrary Coherence for academic folks)
Marketers will keep you convoluted with options to lure you towards the most expensive option.
The key to avoid falling into these traps is to be aware of these misleading effects. Knowing your priorities will stray you away from unwanted purchases.
Before buying something, it's helpful to evaluate its potential value in your daily life.
In my case, I ask questions like these to myself whenever I shop:
- What will happen to me if I don't buy this product? - If the answer is not a life-or-death scenario, reconsider, reconsider, reconsider.
- Will I even wear this top everyday?
- Are these pants wearable in my workplace?
- How will this cosmetic product help me with my personal and professional goals?
- Are there cheaper options to live a healthy lifestyle? (Context: healthy, organic stuff are so expensive in Manila)
- Is that product really worth the outrageous price tag? Will the cheaper options be as good?
- Is it just expensive because of the brand?
Well, to avoid analysis-paralysis, here's the bottomline: Remind yourself to buy only what you need, amidst the discounts and promotional schemes.
"Chapter 1: The Truth About Relativity." Predictably Irrational: The Hidden Forces That Shape Our Decisions. New York, NY: HarperCollins, 2009. N. pag. Print. ↩
Image Source: Howard, Brian Clark. "The Rise of Eco-Friendly Pearl Farming." National Geographic. National Geographic Society, 12 Aug. 2013. Web. 29 Mar. 2017. http://news.nationalgeographic.com/news/2013/08/130811-eco-friendly-pearl-farming-kamoka-polynesia-oysters-environment/. ↩
"Chapter 2: The Fallacy of Supply and Demand." Predictably Irrational: The Hidden Forces That Shape Our Decisions. New York, NY: HarperCollins, 2009. N. pag. Print. ↩