If I asked you how much a given item costs, you would likely be able to spit out a reasonably close guess as to how much it costs. There is an entire TV show devoted to this idea – The Price is Right. For the sake of testing this idea, I’m calling you to “come on down” and take a guess at the price of a gallon of milk, an iPhone, and a Toyota Prius.
Below are the answers:
- A gallon of milk ~ $3.30
- An iPhone ~ $450 – $1500
- A Toyota Prius ~ $23,770 – $28,820
How close did you get? You probably got decently close. But where did your guess at the prices come from? How did you know how much these items cost or how much they ought to cost?
In this post, I am going to share some information about how people decide how to price items and the inferences that we can make about other aspects of human decision making based on observations from behavioral economics.
Dan Ariely and the “Gosling Effect”
Dan Ariely is a Professor of Psychology and Behavioral Economics at Duke University and formerly a professor at MIT. He has founded/co-founded multiple companies and serves as the Chief Behavioral Officer for 2 other companies. He is also the author of 7 books. It seems like he likes to stay busy.
In his book Predictably Irrational, he shares the an idea called “arbitrary coherence” – what I am calling the “Gosling Effect” here.
No! Not Ryan Gosling. Baby geese!
Dan Ariely starts explaining the concept of arbitrary coherence by telling the story of Konrad Lorenz. Lorenz, a naturalist, learned that gosling will imprint on the first moving object they encounter and follow it until their adolescence. Usually the first moving thing they see is their mother, but during one of his experiments he became the first thing they saw. As Dan explains, “Lorenz demonstrated not only that goslings make initial decisions based on what’s available in their environment, but that they stick with a decision once it has been made.” The initial decision dictates their future decisions.
Dan goes on to demonstrate that humans, just like the goslings, follow this same pattern when making economic decisions. Dan goes on to tell of how Salvador Assael introduced black pearls into the jewelry market. When Assael introduced the black pearl there was no demand for the item. Their monetary value was undetermined. Sure, there were labor costs in getting the pearls and transporting them from the harvesting site to the store but their monetary value is unclear and largely subjective. Assael convinced Harry Winston, the legendary Gemstone dealer of New York City, to put them on display with an outrageously high price tag among diamonds and rubies. Soon enough, black pearls were seen on the necks of New York’s wealthiest women. Below is a price I found for a black pearl necklace:
As you can see by the marking “ITEM IS SOLD OUT,” people are willing to pay $45,000 for a black pearl necklace largely because of a “arbitrary” starting price introduced in the 1970s. Our first exposure to a type of item will “anchor” an expectation about how much an item ought to cost for the long term. Once a price is anchored, related items will be judged in a “coherent” or consistent manner. Bigger pearls will cost more. Smaller pearls will cost less. In Dan’s words, “although initial prices (such as Assael’s pearls) are ‘arbitrary,’ once those prices are established in our minds they will shape not only present prices but also future prices (this makes them ‘coherent’).
Demonstrating the “Arbitrary” Nature of Starting Prices
In an experiment at MIT, Dan Ariely and some colleagues demonstrated the arbitrary nature of starting prices with a quick experiment. The experimenters introduced a series of items to the student to include:
- A 1998 wine rated at 86 points by Wine Spectator (wine)
- A 1996 wine rated at 92 points by Wine Spectator (rare wine)
- Cordless track ball
- Cordless keyboard and mouse
- Book
- Belgian chocolates
The experimenters asked students to write the last two digits of their social security number on a page of paper at the top. Then they asked the students to write the last two digits of their social security number in the form of a price next to each item. 45 = $45. Next they were asked, would they pay $45 for the item (yes or no). Finally, they asked students to write down the maximum amount they would be willing to pay for the items.
The results are unbelievable. The act of writing the last two digits of their social security number in the form of a price next to the items seemed to influence what the students bid for the items. The results for the two wines are depicted below:
As you can see above, the higher someone’s social security number, the more likely it was that they would bid a higher amount for the item. The difference in dollars between the people in the 00-19 group and the 80-99 group was about $20 for the two wines. Writing their digits as a price “anchored” their expectations on how much they ought to pay for the item.
Dan further illustrates examples of anchoring in our daily lives that influence how much we are willing to pay for items like:
- MSRPs of cars
- A real estate agent’s spiel about average home prices in your area
- The first time you buy a LCD TV. In fact, the first time you buy any new type of item sets your anchor for that type of item.
- Not so surprisingly, people who move from expensive areas like California tend to spend the same amount on housing even when moving to a more affordable part of the country.
Once you have a set pricing anchor it sticks with you. The starting price for an item is largely arbitrary, but once they are set the starting price shapes how much we are willing to pay for an item and related products.
Getting Philosophical for a Minute
These observations about how people come to accept prices are not just matters of economics; the observations speak volumes about the nature of human decision making. In previous posts, I shared some thought about the effects of time pressure on decision making and the limits of human free will. These ideas coupled together suggest that human decision making is easily influenced and shaped by factors that we often aren’t aware of.
What if the lives we shape for ourselves aren’t freely crafted? What if we’re just following first decisions like the gosling?
As Dan puts it, “Could it be that we made arbitrary decisions at some point in the past (the goslings that adopted Lorenz as their parent) and have built our lives on them ever since, assuming that the original decisions were wise? … Suppose that we are nothing more than the sum of our first, naive, random behaviors. What then?”
Dan continues, “Socrates said that the unexamined life is not worth living. Perhaps it’s time to inventory the imprints and anchors in our own life. Even if they once were completely reasonable, are they still reasonable? Once the old choices are reconsidered, we can open ourselves to new decisions – and the new opportunities of a new day. That seems reasonable.”
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