How Behavioural Economics can help us in redefining rationality

One of the basic concepts in economics is of utility and how humans derive utility from things and thus decide their worthiness. This is the reason why one doesn’t want to eat another chapatti after having 4 of them or why companies offer bulk discounts. It basically takes into account that as one consumes a good, it’s marginal utility decreases consecutively and finally turns negative.

Price anchors guiding consumer behaviour

But what about those pair of jeans that one might think is cheap, but their friend thinks is extremely expensive even after a discount? Now, this is governed by what is known as Price-Anchors. Whenever one buys something for the first time, they set an anchor for the price that they might be willing to pay for that thing. Whenever they buy that item, that price anchor will decide whether they are getting a good deal or not.

Price anchors take time to get revised, but over a period of time, they can change due to many reasons. Having a look at avid Online Shoppers in India can reveal that. E-commerce companies give away huge discounts, thus revising the anchors for all the people. The discounts which were earlier given to incentivize people to buy things online has led to people expecting discounts on everything. Price anchors can also be relative which could happen when one first buys a pen and expect its price from the price of the pencil that they have been buying.

Creating a new market for sound

Quoting an example from the book Predictably Irrational, Dan Ariely experimented to make a new market for sound. In the experiment, some people were asked to pay some amount for listening to a sound and some were given some money to listen to the same sound. Since there was no pre-existing market for the same, people were later asked how much were they willing to pay or receive for listening to that sound accordingly. People who were told they were to pay for that sound happily paid (and gave a price for it) and those were told they will be receiving some money in return happily accepted money for the same sound. Now for this new market, there were no price anchors in the minds of people. However, after some time when people were expected to play a part in developing a market, it was heavily influenced by the situation that a person was in and not what was so-called “Rational”.

Overcoming limitations by utilising Behavioural Economics

Marketers know their limitations very well and that’s why they use it to define a niche market space for themselves to demand “Rationally Unreasonable” amount for their products. As that niche market space slowly swells with more brands coming in with the same features that made it ‘niche’, the prices drop and the market no longer remains niche.

An experiment was done which required people to collect 8 stamps for a car wash and stamps were given to people who purchased products over a certain amount. Now, there were 2 sets of people — one was given the task of completing 8 stamps and the other was given the task of completing 10 stamps, but 2 stamps were given by default. At the end of the study, it was noted that people who were given 2 stamps were more willing to complete the task of collecting all the stamps as compared to the other group. At the heart of this example is our tendency to complete tasks which are semi-complete over those tasks which need to start afresh. Using this technique, marketers tend to drive action by completing a part of the action by default. For Example Chances of getting a form completed when it says “50% complete” by default is more than if nothing is said about the default completion.

Affecting decision making by analysing rationale

Since a long time marketers have been using behavioural economics to make consumers make choice in the firm’s favor without even realizing. The next example comes from a well-known practice among the restaurants in the United States. In the States, restaurants which see a decreasing sales volume for their most exclusive and eloquent dishes (and obviously the most expensive dishes on their menu) introduce a few dishes more expensive than the dishes in question to act as a decoy. Here these decoys do nothing to get chosen by the customers but present them with a benchmark to compare prices to.

Whenever humans are faced with choices, they require things to compare for making a decision. Thus companies sometimes provide a decoy just to drive demand for the product in question. As far as the restaurant example is concerned the restaurant saw an increased demand for that eloquent dish just by introducing some more expensive dishes. So the problem was not that people didn’t want to buy those dishes in question but didn’t want to buy the most expensive ones on the menu. Similarly, companies introduce different screen size models for TVs just to drive demand for some specific sizes. Ever wondered why everyone seems to prefer 32 inch TVs more than any other size? Maybe the companies just wanted so.

Marketers using rules to increase sales

In Economics, people are aware of the basic principle of demand and price for normal goods. More the price, less the demand and vice-versa. That is very well true but only when people buy things using money. Studies suggest that people experience pain similar to physical pain while they have to pay money for buying things. Probably that’s the reason why men don’t like to go shopping. But this physical pain points can be avoided by introducing a secondary method for transactions. Ever wondered why Amazon gives away discounts on use of credit cards? Or Virtual Games demand virtual coins to be purchased first which could further be used to buy in-app features and items. Similar to the restaurant example, menu’s which don’t have currency placed next to the price of items get more orders and of higher per order value than those who do.

Effective personalisation of products

IKEA, which is the leading Swedish home furnishing company, sells furniture in pieces which have to be put together by the consumers, which might seem cumbersome at first but as the story rolls out it isn’t. The entire idea of IKEA is to get consumers to make their own furniture and add a sense of emotional attachment to it. The same strategy is used by a lot of firms including customizing t-shirts and cups etc. This way the consumers have a sense of belonging and ownership with the product and thus the products get valued more. This is popularly known as the IKEA effect. Similar to this effect is the endowment effect which makes consumers value items they own more than item owned by someone else. This gives rise to what is called “Cognitive Dissonance” or “Buyer’s Remorse” which drive people to second their own choices made in the past even though their opinions and tastes might have changed.

Thus, Challenging the Assumption of Rationality in Economics is as difficult as defining Rationality itself. It is imperative for us to understand that it is not about defeating the models of rationality but to evolve them to make people understand economics in a more holistic manner. Inviting opportunities to revoke the assumptions will help us understand economics better as economics is nothing but an understanding of human behavior and no one can challenge it but us.