Price Relativity and Behavioral Economics [Poll Results]

After two days of polling for my Frugality and Decision Making question, here are the results of my casual survey. As with my monkey poll question, each visitor was randomly given one of two different poll questions. I really love that you all put so much thought into your decision, but in fact the point I was trying to get across was a bit different.

As you can see, the only difference between two questions is the original price of the item being purchased. In both cases, you are deciding whether you want to save $7 by spending 15 minutes of your time. $7 is $7. Or is it? The vast majority of readers would take the 15 minutes for a $25 pen, but the vast majority would also not spend the 15 minutes for a $455 suit.

The Answer is Relativity.

Humans are trained to base our decisions in a relative manner, and compare them to whatever is available. We hate making decisions in a void. In this case, your mind may have trouble deciding if a $7 savings is worth it, so it goes straight for the price. In this case, $7 is savings of nearly 30% for the pen, and less than 2% for the suit. The decision is now easier, even though it may not make rational sense. We should think about money in a more absolute manner, but we tend not to.

More Examples of Relativity

  • Think about how happy you are with your current salary. Now, imagine your co-worker who is junior to you gets paid $5,000 more a year. Much less happy now, right? H.L. Mencken noted that a man’s satisfaction with his salary depends on whether he makes more than his wife’s sister’s husband. :shock:
  • Rome or Paris? Let’s say you love Paris and Rome equally, but have to decide between a Paris trip with hotel/airfare/free breakfast, a Rome trip with hotel/airfare/free breakfast, or a Rome trip with hotel/air but no free breakfast. Most people will proceed to pick Rome with free breakfast, because in that case you can make a comparison where you are making a clearly “superior” choice.

    Given three choices, A, B (distinct, but equally as attractive as A), and A- (similar to A, but inferior), we will almost always choose A, because it is clearly superior to A-.

    When Williams-Sonoma started selling a bread machine, sales initially were slow. But after they added a new “deluxe” version that was 50% more expensive, they started selling a lot. People now saw the first bread machine as a bargain.

  • Have you ever rationalized an additional purchase because you’re already spending so much? When catering a large event that costs $5,000, a person may not think twice about adding a soup entree for an additional $200. The same person may get really excited when saving 50 cents on a can of soup.
  • Which dot is bigger?

Often, simply acknowledging our tendencies and trying to think more broadly can help up make better decisions in the future.

As some of you have figured out, the idea for this week’s poll question and many of the examples above came from a book called Predictably Irrational by Dan Ariely, which explains how humans don’t always respond perfectly logically. (The actual poll question is from a study by well-known researchers Amos Tversky and Daniel Kahnemann.) I hope to put up more poll questions from this book (so don’t spoil them please :)), as I find it much more fun and interactive than a book review.

Comments

  1. I also think the fact that your 15 minute trip is being over looked when it really could be a half hour trip (15 minutes both ways), plus the fact that you are spending more on gas, extra wear on your car and more. So that 15 minutes for $7 is actually a lot less that you are getting, in in actuality would cost you more.

  2. I didn’t receive the pen question when I took the survey, only the second one.

    So, what is the point to it? That we should save the $7 both times, regardless of the overall price?

    BTW, I’d never spend that much for a pen anyways…

  3. Dan, he never mentioned that it was 15 minutes away BY CAR. He also did not state that it would 15 minutes in the opposite direction of your next destination. It could easily be 15 minutes by foot or bus, and it could be lateral or even closer to your next destination.

    So let’s just take the questions at face value – the point of the questions was “is your time worth $28/hour after-tax?”

  4. I agree with the basic premise of this article and the previous poll, and don’t understand the debate made in other comments. Saving money is saving money, regardless if it is a pen or a suit. I only care about the money that stays in my pocket. The illogical arguments don’t sway me, and maybe that’s why I’m an engineer.

  5. Yeah, I didn’t see the pen question either. BUT, I figured out the angle anyway. I knew it!

    I think it’s funny so many people said it wasn’t worth the time or wear or tear, emmissions, etc., for $7. Are these the same people who answered the pen poll?

    My dh highly recommended the book – I need to get around to reading it.

  6. Although I answered “no” to both of your questions (I vistit your blog more than once a day, I guess), I can definitely see where relative decision-making comes in to play. For instance, when buying a house for multiple hundreds of thousands of dollars and you show up to the closing table I typically don’t scrutinize items in the closing costs that may be for hundreds of dollars when other any other circumstances an expenditure of hundreds would receive a lot of scrutiny before making the decision. I honestly think service providers may take advantage of this. Another example is a wedding. Once you are resigned to the fact that this event is going to cost more than you expected a thousand dollar cake seems okay, where under any other circumstances there is no way you’d be willing to pay that kind of money for a cake!

  7. I said yes to saving $7 on the suit, but had to justify it –e.g., assume it was a 15 minute walk (so no gas used), the cheaper suit was in an area I don’t frequent (so it’d be nice to visit again), etc.

    I suspect my decision would have been easier if I were saving $7 on a pen — i.e., I’d feel less like a cheapskate for saving $7 on a pen than $7 on a suit, though the dollar amount of what’s saved is the same.

  8. Another SHOPPING MATH:
    Men will pay $20 for a $10 item that he needs.
    Women will pay $10 for a $20 item that she does not need.

    Any good survey on this?

  9. One of my co-workers will scrutinize $600 expenditures on projects with $5M budgets. I can usually explain variances on my projects just looking at the bigger 4-figure numbers. He may be more rational–a dollar is a dollar–but he spends a lot of time and frustrates a lot of people doing it. Maybe I’m rationalizing my irrational behavior, or perhaps I’m guilty of playing by looser rules, since it’s somebody else’s money.

    The cool thing about well done polling is that it can isolate individual tendencies. Real life, on the other hand, gets messy.

  10. there are similar insights from a book i am reading called “Nudge” where they distinguish rational beings who would not be swayed by the illogical tendencies you are pointing out (“Econs”) from us regular people (“Humans”). cool stuff!

  11. Well, relative prices do matter. If there was that big of a difference for an otherwise identical pen, that’s a pretty good arbitrage opportunity right there ;) Sure, the suits is the same absolute difference, but $1000 will buy me a lot more pens than suits…

  12. LargeTalons says:

    @David: The point is that no matter what the answer, it should be the same answer to both questions. People tend to believe they are saving “more” when the percentage goes up, even though its the same amount of money.

    @Andy: I think you’re right about the house buying thing. Most people probably write off costs in the hundreds of dollars when purchasing something that costs hundreds of thousands. I would certainly be guilty of that, you sort of think “Well, whats another $500 if I’m already spending $200,000?” Where, normally, I would probably question spending $500 for that same item/service outside of the home buying process. An entire industry thrives off that :)

  13. questions don’t make sense as frugal people would not spend that much on either item

  14. Awesome post! Thanks for sharing the results with us. My rationale was I live in the city so a 15 minute walk is nothing (and if it’s not raining) totally worth it.

  15. As a consumer it’s important to me that I set up systems for myself that allow me to save over time. I have bought one house in my lifetime, so losing a few hundred here or there was not a big deal since I’m not expecting to buy a new one for a while. Some items like bread I buy very regularily. When I save $1 on bread it’s not me saving $1…it’s me designing a system to possibly save me hundreds of dollars over time. I have bought one suit in my lifetime so I don’t care about setting up systems there. I do buy many $25 items though, so I wouldn’t want to get in the habit of overpaying for them all of the time. So how often one is expected to buy that product *should* matter. 15 minutes+driving costs to save $7 wasn’t worth it to me though.

  16. I really like these posts and questions. They’re very interesting and I think good to continue.

  17. Dave is right about why this whole premise is WRONG. You make ten times as many $50 decisions as $500 decisions. Sorry, it’s not true just because you read it in a book.

  18. Of course it isn’t true simply because it is in a book. In this case it is true because it is supported by mountains of data from experiments (including one run right here on this blog in the last few days) and it is in the book because it is true.
    Dave, interesting perspective but I’m not wired that way. I have trouble dismissing overpaying a few hundred dollars even on a one-time purchase. To me that just looks like erasing almost six year’s worth of bread savings!

  19. Kevin, although I truly relate as I am an engineer* too, I think that the poll/experiment is missing an important point: frequency. You are likely to buy 25$ items a lot more frequently than 450$ items. So saving 7$ on a 450$ suit seems pointless since you will not make 2-3 of these transactions a day.

    When looking purely at the question, both “15mins” were worth 7$. But that is not how readers analyze it. They apply the general rule they use everyday (and that’s the point of making polls or experiments). And when presented with a large % bargain on an item, then you should move in.

    You save more if you mobilize 18$ to save 7$ than if you mobilize 455$ to save the same amount. Only when both items must be bought than it does not make a difference. Think and stock: the same logic applies.

    The wedding or house examples are just as good: you will not buy a house every month. So saving 200$ on its price is a one time saving. While saving 200$ on your BBQ, then on a bicycle, then on … Makes more sense. Just look at your credit card statement: mine is all 25$ items that amount to a lot with very few 450$ items.

    I must admit however that if we base our reasoning *strictly* on the poll questions, one would have to agree that 7$ is 7$.

    *How do you know who are engineers in a bar? No need, they’ll come and tell you!

    ** And yes, I am a happy man because I *DO* make more than my wife’s sister’s husband. ;p

  20. christine says:

    i like! more polls!

  21. I agree with what Geeho says. However, similar thoughts (ie. when Andy says “To me that just looks like erasing almost six year’s worth of bread savings!) have crossed my mind when paying the extra cost for higher valued items. I faced this dilemma last week when booking airline tickets. Do I pay $25 more for tickets costing well over $200 for a flight time where I would need to wake up couple of hours earlier? I almost paid the $25 extra, but then decided not to when I realized that I try to save $1 on low valued items.

  22. Great post. Keep it up. Thanks.

  23. is this relative?

    Lets say price of an egg is $0.25 and it goes up to $0.50.

    A price of a car increases from $10,000 to $10,000.25

    Is it the same if u want to buy both? Shudnt the ‘hurt’ in the price increase be the same for both items?

  24. Humans are flawed creatures. The relativity of the item causes the different decision to be made. Your forgetting the value of your time. Going that extra distance on a particular item says nothing. Someone who is lazy or late for an appointment values their time above the cost.

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  1. [...] of behavioral economics topics you may be familiar with by academics like Daniel Kahneman and Dan Ariely. For example, you probably get excited when you buy something marked down 60% at the mall. [...]

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