More than two years ago, I got myself a PlayStation Portable (PSP) (accessories included) at a cool 550 bucks. Unfortunately, what wasn’t so cool was that I really could have gotten it at 400 or less – needless to say then that I got scammed. To establish a clearer picture: I was at Sim Lim Square. If you don’t already know how things work there, you will find out by the end of this.^
I did my fair share of homework by comparing prices across the different shops, and interestingly enough they all quoted the same price: $400. So I picked a shop at random and asked to try it; before I knew it, he was already pushing all his accessories to me.* In all fairness, he was a very good salesman (albeit a very dishonest one too) and I found myself thinking I got a real bargain. Just a day later, I became the laughing stock back in camp.
Our problem here is certainly one of ethics – if I’d been less trusting, I could have gotten the accessories at a much lower price. On top of that, I should have done more to find out the typical price and the better places to get it. Still, this doesn’t quite answer the question as to why I spent almost 50% more on accessories I didn’t need!
The anchoring effect was first introduced by psychologists Daniel Kahneman and Amos Tversky. One of the experiments the former conducted was the United Nations game, in which he asked people to estimate the percentage of African countries in the UN. Before they guessed, he would generate a random number in front of the participants by spinning a roulette wheel. As you might expect, the people who saw higher numbers on the roulette wheel systematically generated higher guesses for the percentage of African countries.
In Predictably Irrational, behavioral economist Dan Ariely writes:
Suppose you have two errands to run today. The first is to buy a new pen, the second is to buy a suit for work. At an office supply store, you find a nice pen for $25. You are all set to buy it when you remember that the same pen is on sale for $18 at another store 15 minutes away. What would you do? Most people faced with the dilemma say that they would take the trip to save the $7.
Now you are on your second task: you’re shopping for your suit. You find a luxurious gray pinstripe suit for $455 and decide to buy it, but then another customer whispers in your ear that the exact same suit is on sale for only $448 at another store, just 15 minutes away. Do you make this second 15-minute trip? Most people say that they would not.
As you might realize, $7 is $7 however you look at it. If we’re rational, and 15 minutes of our time is worth less than $7, then why do we decide differently in both cases? Dan goes on to say: “This is the problem of relativity – we look at our decisions in a relative way and compare them locally to the available alternative.” In other words, $7 seems a lot as a fraction of the cost of the pen, making it obvious that we should spend the extra 15 minutes to save the $7. As a fraction of the cost of the expensive suit however, it is far less significant. Hence, we decide to spend the extra $7.
Clearly, this anchoring heuristic is well-positioned to explain how I ended up spending so much more on the accessories. This devil, as I now see, warped my impression of the value of money when I compared it with the cost of the PSP. Anyone (including me) with the right mind probably wouldn’t spend $150 on accessories alone, but at that time, topping up the $150 didn’t strike me as that significant. On hindsight, I really could have spent it in a thousand better ways.
My example might be a little extreme – after all, $150 out of $400 is definitely not insignificant (but hey, you have to consider the high-pressure sales tactics involved). Nonetheless, this is a common mistake we all make in our daily lives. It’s certainly not easy to stop judging things relatively, but one method works for me: think about the opportunity cost of the extra money you’re spending. If you’re contemplating upgrading your current purchase at a cost that’s insignificant relative to the cost of the purchase, think about all the other things you could do instead with that money. That way, your upgrade doesn’t seem like such a bargain anymore.
This applies to sales as well – we typically come out of sales much poorer than we expect to be because “it was such a bargain! I would have been a fool not to buy it.” But if we first think about what the item is really costing us, we might be able to make decisions more rationally. For example, you might see a top for sale at $10 when it usually would have cost $100. It looks like it’s a savings of $90, so you decide to buy it. Of course, you know full well that will never wear this (as always is the case with sales). And unfortunately, what’s really happened is that you’ve made yourself $10 poorer.
In true consumer spirit,
*: One of the accessories, I was told, was a pair of earphones. He handed them to me only after I paid up (and after a reminder). To my horror he had only pink ones left. Needless to say, I’ve never used it.
^:It broke down less than a year after I bought it and I tried to get it repaired under my 1-year warranty. When I went back, I was told that they’d changed ownership and I’d have to pay.