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In making decisions, humans tend to make comparisons to determine relative values. Let’s say<br />

you are shopping for an inexpensive book (Roget’s Thesaurus) which you have found in your<br />

college bookstore priced at $12. A fellow student informs you that an off-campus bookstore has<br />

the same book priced at $2. Would you make the trip to the off-campus bookstore to save $10?<br />

You probably would, since $10 seems like a huge savings relative to the price of the book. Now<br />

let’s say you are shopping for an expensive textbook (chemistry) which you have found in your<br />

college bookstore priced at $275. A fellow student informs you that an off-campus bookstore has<br />

the same book priced at $265. Would you make the trip to the off-campus bookstore to save $10?<br />

You probably would not, since $10 seems like a trivial savings relative to the price of the book.<br />

In making decisions, humans tend to get “anchored” to the first information that they receive. Let’s<br />

say that 100 college students are shown a new app for their smart phones. They are asked,<br />

“Would you be willing to pay $50 for this new app?” Then they are instructed to “write down the<br />

highest price that you would be willing to pay.” A different group of 100 college students are<br />

shown the same new app. They are asked, “Would you be willing to pay $1 for this new app?”<br />

Then they are instructed to “write down the highest price that you would be willing to pay.” The<br />

first group of students would almost certainly indicate a higher price than the second group of<br />

students. There is no rational reason that a suggested price should influence how highly the<br />

students value the app. But “anchoring” leads to irrational behavior.<br />

In making decisions, humans are influenced by the irrational power of the zero price effect. If you<br />

were offered a choice between buying a $20 iTunes gift card for $12 or buying a $10 iTunes gift<br />

card for $4, you would probably choose the $20 gift card, since the savings is greater, $8 versus<br />

$6. But if you were offered a choice between buying a $20 iTunes gift card for $8 or receiving a<br />

$10 iTunes gift card for free, you would probably choose the $10 gift card.<br />

In making decisions, humans are influenced by social norms versus market norms. Your friend<br />

asks you (as a favor) to help him move to his new apartment. This will take a few hours on<br />

Saturday, and you are happy to do it. Alternatively, your friend offers to pay you $10 to help him<br />

move to his new apartment. The offer of pay moves this from social norm to market norm, and the<br />

pay seems inadequate. You decline.<br />

Other examples of predictably irrational behavior discussed in the book include:<br />

(1) The powerful effect of emotional arousal on decision-making.<br />

(2) The tendency to procrastinate and to fail to exercise self-control.<br />

(3) The “endowment effect”; the tendency to overvalue items that we own.<br />

(4) The difficulty of choosing between similar options.<br />

(5) The effect of expectations, e.g. food served on fancy china will taste better to us than the<br />

same food served on paper plates.<br />

(6) The effect of price on the placebo effect, e.g. an antihistamine that costs you 10 dollars will<br />

relieve your allergies better than an antihistamine that costs you 10 cents, even if the drugs<br />

are chemically identical.<br />

(7) The tendency to consider ourselves as basically honest, while also tending to cheat when the<br />

the opportunity arises.<br />

(8) The tendency to cheat less when money is involved, e.g. we may take a pencil worth 10<br />

cents from work, but we won’t take 10 cents out of the petty cash drawer to buy a pencil.<br />

Appendix: Think Like an Economist – Rational Robbers<br />

If the government responds to an increase in the incidence of liquor store hold-ups by passing a<br />

law that makes the punishment for armed robbery the same as the punishment for murder, there<br />

will be fewer liquor store hold-ups. If you work at a liquor store, will you be happy about this<br />

change in the law? Thinking like an economist (remembering that rational people respond to<br />

incentives), how would you expect the behavior of armed robbers who continue to rob liquor<br />

stores to change in response to the new law?<br />

FOR REVIEW ONLY - NOT FOR DISTRIBUTION<br />

1 - 11 Scarcity and Choices

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