Monday, January 16, 2012

anchoring effect

Are you as annoyed as I am when you're told by the grocery cashier how much money you just saved? In your head, you know you didn't save anything. In your heart, though, you want to believe that that bottle of wine you paid $12 for was really worth the $16 that was posted as the price for non-members of the "Savings Club." If there were just one or two items on sale, you might believe you really did save some money. But when just about everything in the store has two prices--one for the "members" and another higher price for the "others"--you probably realize something fishy is going on. You're right. The grocery markets are using the anchoring effect to make us think we're saving money. If we save money, we'll like them and come back. But it's all a con. Each one of the higher prices that the non-members pay is an anchor point that the grocer is hoping you will use to buy things that did you not plan on buying. But, at such a bargain, how can you pass it up? You can tell your friends that you saved $4 on a bottle of wine you didn't intend to purchase in the first place. Isn't that great?

If you're like me, you have no idea what the true value of a bottle of wine is.There may be twenty zinfandels on the shelf priced from $5 to $50. Given a few variables such as the year of harvest, the size of the winery, and the distance to the source, you would think the cost of producing the various bottles on the shelf does not differ all that much. So, you might think that the price is set by some rational standard, such as supply and demand. The higher-priced wines are rarer than the lower-priced wines. Maybe the higher-priced wines have some superior quality that makes demand for them very strong. Maybe the lower-priced wines have an inferior taste and so the demand is low. On the other hand, maybe the pricing isn't rational at all. The seller picks a number, the retailer adds whatever profit he thinks the market will bear, and that is either the number you are given or, in the case of the "savings club" markets, you're given two numbers: one as an anchor point, the other as the price of the wine. In either case, there will be other bottles of wine priced from high to low near the one you're considering. Those other prices can serve as anchor points. Some of us will focus on the higher priced wines and pick the highest priced wine, thinking it is probably the best since it costs the most. Of course, we have no information that would validate this thinking. Or, we might use the top price as an anchor point and choose a wine that is marked down 20% from a price near the top. Again, we have no rational basis for this choice. Or, we might pick a medium-priced wine just because it is a medium-priced wine. Or, we might pick a wine that is one notch above the lowest-priced wine on the shelf on the grounds that it will probably be a better tasting wine for the value. For all we know, the retailer prices his cheapest and least attractive wine one notch above the lowest-priced wine to entrap thinkers like you. In any case, it seems like the only rational consumer of wine is the one who buys a wine he or she likes. My experience has been, both in the market and in the restaurant, that there is little correlation between the price of the wine and whether I'll like it. Some restaurants are pretty sophisticated at using anchor points in wine-list pricing, leaving me to conclude that maybe a rational person shouldn't buy wine. Let somebody else buy it for you.

Our judgment regarding the frequency, probability, or value of items is often determined by comparing the item to an anchor point. Often, the anchor is an irrational bias that determines a decision. The bias can be measured and expressed in percentages. For example:

In an experiment conducted some years ago, real-estate agents were given an opportunity to assess the value of a house that was actually on the market. They visited the house and studied a comprehensive booklet of information that included an asking price. Half the agents saw an asking price that was substantially higher than the listed price of the house; the other half saw an asking price that was substantially lower. Each agent gave her opinion about a reasonable buying price for the house and the lowest price at which she would agree to sell the house if she owned it. The agents were then asked about the factors that had affected their judgment. Remarkably, the asking price was not one of these factors; the agents took pride in their ability to ignore it. They insisted that the listing price had no effect on their responses, but they were wrong: the anchoring effect was 41%. (Kahneman, Daniel. 2011. Thinking, Fast and Slow. p. 124.)

That is, the difference in lowest asking price between the low anchor group and the high anchor group was 41%.

If the label on a coat in a clothing store has a price tag with three different prices, the two highest of which are crossed out, you may think you are getting a bargain if you accept the highest price on the tag as an anchor.

Mentalists can exploit anchoring by knowing that when asked to pick a number "people tend to pick one close, or anchored on, any number with which they are initially presented or in the case of a scale one close to the midpoint" (Sutherland, Stuart. 1992. rev. 2nd ed. Irrationality. p. 168).

Robert Levine gives an example of how a cable company that was raising its rates used the anchoring effect to make it appear that they were saving people money. They announced that the rumor that rates were going to go up by $10 a month were completely bogus. "You can relax. It's not going to happen. The great news is...the rate for basic cable is only increasing by $2 a month" (Levine, Robert. 2003. The Power of Persuasion - How We're Bought and Sold. pp. 100-101).

Behavioral economist Dan Ariely (Predictably Irrational: The Hidden Forces That Shape Our Decisions. 2008 ch. 2) reports on experiments he and colleagues have done that demonstrate the power of suggestion in establishing arbitrary values of goods and services as anchors. Combined with our tendency to try to be consistent, Ariely explains how we are easily manipulated into patterns of "arbitrary coherence." Once we have an anchor price in our mind, it will shape not only how we view present prices but future prices as well. In one experiment, he has the subjects write down the last two digits of their social security number. He then asked them if they would pay that amount (say $79 or $12) for a bottle of Côtes du Rhône 1998. Not only did the social security number affect the price the subjects were willing to pay, it also affected the price they were willing to pay for a bottle of 1996 Hermitage Jaboulet La Chapelle. The subjects were not wine experts but the lower their social security digits, the lower the price they were willing to pay for the wine. The correlation for both bottles of wine between social security number and price they'd pay for the wines was 0.33. (A value of 0 would mean there was no relationship. A value of 1 would mean the items were perfectly correlated, i.e., as one went up the other would go up to the same degree.) Not only did the arbitrary social security number affect what value they put on the first bottle of wine, it affected the value they put on a completely different bottle of wine. The experiment covered six different items and the results were similar for all items.

The implication of arbitrary coherence is that it calls into question one of the basic assumptions of a free market and free trade. If we can be manipulated to value things in arbitrary ways, the alleged benefits of a free market are called into question. If values aren't simply matters of supply and demand evaluated by rational creatures who know what they want and need and how much they are willing to pay for it or charge for it, then it is the manipulators who stand to benefit from free trade. Traditional economics has defended a free market economy on the assumption that human beings are generally rational in their market behavior and choices. More and more, scientists like Ariely are establishing that our market behavior is more irrational than rational. Think of the anchoring effect the next time you are tempted to purchase something labeled "limited to 12 per person." 

The following example might convince you that the anchoring effect can have some serious consequences.

The power of random anchors has been demonstrated in some unsettling ways. German judges with an average of more than fifteen years of experience on the bench first read a description of a woman who had been caught shoplifting, then rolled a pair of dice that were loaded so every roll resulted in either a 3 or a 9. As soon as the dice came to a stop, the judges were asked whether they would sentence the woman to a term in prison greater or lesser, in months, than the number showing on the dice. Finally, the judges were instructed to specify the exact prison sentence they would give to the shoplifter. On average, those who had rolled a 9 said they would sentence her to 8 months; those who rolled a 3 said they would sentence her to 5 months; the anchoring effect was 50%. (Kahneman, Daniel. 2011. Thinking, Fast and Slow. pp. 125-126.)

At least the judges who sentenced the shoplifter weren’t affecting any real people by their decisions, but it makes you wonder if the time of day might affect a judge’s judgment. If you are sentenced at 9 am you may get a stiffer sentence than if you are sentenced at 2 pm. Who knows? We do know, however, that whether a judge is hungry or tired can affect judgment. Again, the example comes from Daniel Kahneman via a report in the Proceedings of the National Academy of Sciences.

The unwitting participants in the study were eight parole judges in Israel. They spend entire days reviewing applications for parole. The cases are presented in random order, and the judges spend little time on each one, an average of 6 minutes. (The default decision is denial of parole; only 35% of requests are approved. The exact time of each decision is recorded, and the times of the judges’ three food breaks—morning break, lunch, and afternoon break—during the day are recorded as well.) The authors of the study plotted the proportion of approved requests against the time since the last food break. The proportion spikes after each meal, when about 65% of requests are granted. During the two hours or so until the judges’ next feeding, the approval rate drops steadily, to about zero just before the meal. (Kahneman, Daniel. 2011. Thinking, Fast and Slow. pp. 43-44.)

In another study, "accomplished trial judges with an average of more than 15 years of experience were influenced by sentencing demands, even if the demands were made by non-experts."
Judges who considered a high demand of 34 months gave final sentences that were almost 8 months longer than judges who considered a low demand of 12 months. A difference of 8 months in prison for the identical crime. Notably, this influence occurred although both demands were explicitly made by a non-expert: In our study they were given by a computer science student in the role of the prosecutor. (Englich & Mussweiler, 2001)
 Makes you wonder what else is influencing human judgment, doesn't it? And what should be influencing judgment but isn't?


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