Holt 7525-9 S15_IT

In making decisions, humans tend to make comparisons to determine relative values. Let’s say
you are shopping for an inexpensive book (Roget’s Thesaurus) which you have found in your
college bookstore priced at $12. A fellow student informs you that an off-campus bookstore has
the same book priced at $2. Would you make the trip to the off-campus bookstore to save $10?
You probably would, since $10 seems like a huge savings relative to the price of the book. Now
let’s say you are shopping for an expensive textbook (chemistry) which you have found in your
college bookstore priced at $275. A fellow student informs you that an off-campus bookstore has
the same book priced at $265. Would you make the trip to the off-campus bookstore to save $10?
You probably would not, since $10 seems like a trivial savings relative to the price of the book.
In making decisions, humans tend to get “anchored” to the first information that they receive. Let’s
say that 100 college students are shown a new app for their smart phones. They are asked,
“Would you be willing to pay $50 for this new app?” Then they are instructed to “write down the
highest price that you would be willing to pay.” A different group of 100 college students are
shown the same new app. They are asked, “Would you be willing to pay $1 for this new app?”
Then they are instructed to “write down the highest price that you would be willing to pay.” The
first group of students would almost certainly indicate a higher price than the second group of
students. There is no rational reason that a suggested price should influence how highly the
students value the app. But “anchoring” leads to irrational behavior.
In making decisions, humans are influenced by the irrational power of the zero price effect. If you
were offered a choice between buying a $20 iTunes gift card for $12 or buying a $10 iTunes gift
card for $4, you would probably choose the $20 gift card, since the savings is greater, $8 versus
$6. But if you were offered a choice between buying a $20 iTunes gift card for $8 or receiving a
$10 iTunes gift card for free, you would probably choose the $10 gift card.
In making decisions, humans are influenced by social norms versus market norms. Your friend
asks you (as a favor) to help him move to his new apartment. This will take a few hours on
Saturday, and you are happy to do it. Alternatively, your friend offers to pay you $10 to help him
move to his new apartment. The offer of pay moves this from social norm to market norm, and the
pay seems inadequate. You decline.
Other examples of predictably irrational behavior discussed in the book include:
(1) The powerful effect of emotional arousal on decision-making.
(2) The tendency to procrastinate and to fail to exercise self-control.
(3) The “endowment effect”; the tendency to overvalue items that we own.
(4) The difficulty of choosing between similar options.
(5) The effect of expectations, e.g. food served on fancy china will taste better to us than the
same food served on paper plates.
(6) The effect of price on the placebo effect, e.g. an antihistamine that costs you 10 dollars will
relieve your allergies better than an antihistamine that costs you 10 cents, even if the drugs
are chemically identical.
(7) The tendency to consider ourselves as basically honest, while also tending to cheat when the
the opportunity arises.
(8) The tendency to cheat less when money is involved, e.g. we may take a pencil worth 10
cents from work, but we won’t take 10 cents out of the petty cash drawer to buy a pencil.
Appendix: Think Like an Economist – Rational Robbers
If the government responds to an increase in the incidence of liquor store hold-ups by passing a
law that makes the punishment for armed robbery the same as the punishment for murder, there
will be fewer liquor store hold-ups. If you work at a liquor store, will you be happy about this
change in the law? Thinking like an economist (remembering that rational people respond to
incentives), how would you expect the behavior of armed robbers who continue to rob liquor
stores to change in response to the new law?
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1 - 11 Scarcity and Choices