Behavioural economics and consumer issues- (Reference-Peter Winsley)
Anomalies and cognitive biases relevant to
consumer issues Evolution
has left us with a host of psychological characteristics that are inconsistent
with rational modern world assumptions.
Unstable preferences
Preferences are unstable – what is observed at
one point in time changes with time. People value gains and losses differently.
Gains and losses display diminishing sensitivity, so the difference between $10
and $20 seems bigger than the difference between $1000 and $1010. People go to
more trouble to save a small sum (e.g. $5) over a small purchase (e.g. $20)
than saving a larger sum on a larger purchase, such as several hundred dollars
on a house purchase (Camerer et al 2004 p 79).
People assign value to gains and losses
against reference points rather than final assets. So, someone may buy a share
at $5, see it drop to $3, and stay there for long enough for the $3 to become the
new reference point. They then feel a profit has been made at $4 because the
reference point is now $3.
Thinking often anchors
on an irrelevant reference point such as the spin of a wheel, a random
number, unrelated fact, or a credit card minimum repayment rate lower than what
is optimal for the consumer. Salespeople may offer consumers an expensive
product which they do not expect to sell, since this creates an anchor against
which consumers judge a lower cost product to be reasonably priced.
Importance
of framing Framing can alter perceptions of gain or loss. A “discount” is
seen as a gain and a “surcharge” is seen as a loss even when they are
financially neutral. For example when tested, the credit card industry has
insisted that the difference between paying in cash or through a credit card be
framed as a cash discount not a credit card surcharge. Were the
wording the other way round the economic behaviours and outcomes would possibly
be different. Framing influences how risk and uncertainty are perceived and managed.
People will more often decline a medical operation framed as having a 10%
failure rate than one with a 90% success rate, even though the risk is
equivalent. Consumers will perceive differently foods advertised as “95% fat
free” compared to “5% fat”.
Loss aversion, endowment effect and
status quo bias
Individuals are loss averse (Kahneman et
al 1991; Kahneman & Tversky 1984). This may explain why consumers are more
responsive to price increases than price cuts. They place higher valuation on
what they have, compared to what they may aspire to obtain (“a bird in the hand
is worth two in the bush”). Experimentally, people reject 50:50 bets to lose
$100 or gain $105.
People have a bias in favour of the
status quo and current endowments (Thaler 1980). People use heuristic
short-cuts, that is, simple rules of thumb enabling decisions to be made
without going through complex, optimality-based analysis. “Hassles” matter, and
people avoid them through short cuts. Some of these short cuts may be
efficient, though non-optimal, however others may be maladaptive in the modern
world.
People respond to cues or primes, many of
which trigger “rule of thumb” heuristics. It is easier to draw on and apply
familiar associations than to imagine counter-factuals. An availability
heuristic can be employed to estimate frequency or probability by the ease
with which familiar associations are brought to mind. The availability
heuristic creates a bias favouring what is more memorable, vivid or emotionally
charged. The “availability cascade” sees a collective belief become more
plausible through its repetition in public discourse: “repeat something long
enough and it will become true”. These heuristics are in turn related to the recognition
heuristic, where if people have heard of something it must be for a reason,
and so they favour this “something”.
Information and choice overload
People are vulnerable to information
overload, and too many options reduce the likelihood that people will make a
choice (see Schwartz, 2004). Iyengar et al (2004) show that employees’
participation in retirement savings plans drops as the number of fund options
proposed by the employer increases. The number of options offered will
influence the one chosen.
Overconfidence
People tend to overestimate their
abilities and this has consequences for individuals and whole economies. Associated
with this, projection bias or false consensus bias refers to
people over-estimating the likelihood of people acting in the same way as an
individual. Bubbles arise partly because cognitive biases such as excessive
self-confidence at the individual level aggregate into herding behaviour and
major distortions. Over-confidence by investors, lenders and borrowers was one
of many factors that caused the recent global financial crisis.
The confirmation bias means we
privilege information that supports a pre-ordained theory. This bias can
reinforce individual overconfidence. It is associated with hindsight bias where
people exaggerate the prior predictability of an event after it has happened.
Money illusion
Money illusion includes confusion over
nominal versus real values, the illusion of free goods when costs are hidden
and shifted to others, People may not notice a real wage decrease (e.g. due to
inflation) so long as nominal wages don’t fall.
Consideration of sunk costs
People’s reluctance to accept they have
made past bad decisions means they overvalue sunk costs, leading to “throwing
good money after bad” problems.
Misunderstanding of probabilities and of
risk
People overweight small probabilities,
for example when they buy raffle tickets Assessment of probabilities may be
distorted by false or irrelevant cues or associations. The “base rate fallacy”
describes people focusing on particular data only rather than on all data
bearing on a problem. An example is the roulette wheel in a casino. Some tables
have displays which show the recent numbers the ball has landed on in the
wheel. Some punters use this as a guide to predict what number or colour will
come up next, often using the so called ‘trend’ as an indicator when of course
the result of each spin of the wheel is independent of the previous spin.
People often prefer a small probability
of winning a large prize over the expected value of that prospect. There is a
tendency to make risk-averse choices if the expected outcome is positive, but
to make risk-seeking choices to avoid negative outcomes (Tversky & Kahneman
1981).
Different mental accounts
The orthodox economic assumption is money
is fungible, that is “a dollar is a dollar” regardless of whether it is held in
cash, in a superannuation fund or in a property value. People have different
mental accounts (Thaler, 1990; Thaler 1985),
Social norms and herding effects
Humans evolved as a social species where
individuals depend on others for guidance. Social norms are created and
reinforced by observations or cues signalling how society expects individuals
to behave. When a transparent donation box is “primed” with $5 notes rather
than coins people’s average donations will tend to follow this $5 average since
a norm has been established. Negative norms shape individual behaviour: “when
you live among wolves you have to be a wolf yourself.” If everyone else is
littering, you might too. Negative social norms and peer pressure are difficult
for individuals to escape because “to be a stranger among your own is to be
alone among strangers,” and therefore excluded from wider social support. So,
in deciding for example on a default provision a principle may be to align a
default to a positive social norm. For example, organ donation may be a widely
shared and positive social norm, and therefore this could become a default
provision.
Authority
bias
People defer to authority figures,
including politicians and popular celebrities. Authority figures influence
social norms for good or bad: “fish go rotten from the head”. Related to this,
government itself is seen as “authority”. Therefore, that something is lawful
and regulated can imply that government has mandated it, thereby triggering
authority bias and dissuading consumers from rigorous scrutiny of product
offerings. Scarcity bias
The scarcity bias or heuristic (Brannon
& Brock 2001) suggests people consider rare products to be of high value or
quality.
Salience and vividness
The brain privileges first hand
information over abstract symbols. People are over-responsive to rare but vivid
and memorable events such as crimes, terrorism, plane crashes, and are
under-responsive to less obvious, low salient events such as poor diet that
erodes health over time. The cost of taking a taxi is obvious while the
through-life cost of owning and running a car less so. It is common food
industry practice to reduce package sizes rather than increase prices because a
price rise is more obvious and more likely to reduce demand.
Lotto is popular because of the high
salience of the jackpot compared to the low vividness of the minute probability
of winning. Businesses may sell products/services by reducing the vividness of
costs (e.g. “50 cents a day” rather than $182.50 a year, or “for the price of a
cup of coffee a day”). They can also amplify vividness for marketing reasons.
High pressure sales tactics exploit visceral factors and the vividness of
urgency. So, “cooling off periods” are often required to allow reconsideration
of purchases and to counter behavioural tendencies to make early decisions
based on sellers contriving a sense of urgency. These cooling off periods may
be ineffective because of such factors as the way default provisions are prescribed
and procrastination.
Inferential cues
De Steno et al (2004) argue that
persuasion is more successful when messages are framed with emotional overtones
matching the consumer’s emotional state.
Social cues of intimacy, trust or
reliability, and inferential techniques can be exploited in lawful but
misleading ways. An example of an inferential technique is to associate
cigarette smoking with sport, outdoors life, holidays or personal freedoms. Tobacco
companies use brand names such as ‘Freedom’, ‘Holiday’ and ‘Horizon’ to trigger
positive associations and distract attention from health risks.
Present
bias and discounted utility
In evolutionary times, ever-present
danger and uncertainty over even short-term prospects made human psychology
present-centred. It now means that people are likely to be hyperbolic
discounters, in that they over-value the present.
Procrastination
People often procrastinate and if given a
relatively longer time to complete a task will take longer to do so
Practical
applications of behavioural psychology to consumer issues Producers
respond to consumer “needs” and also shape or create those needs through
behavioural psychology. Retailers may reduce the perceived cost of a product by
e.g. labelling it $2.99 rather than $3. They encourage purchase of excessive
quantities by labelling a well stocked product as “limit of ten”. This tactic
exploits several cognitive biases – the scarcity bias, a sense of urgency (“buy
now before they are sold out”), and the anchoring on an upper limit as a target
to aspire to (buying ten not one).
