Confessions of an irrational behaviouralist
Cognitive illusions cloud your judgement — and mine — when it comes to spending
In December of last year, United Airlines, one of the largest US carriers, announced that they would be charging passengers for using the overhead lockers — or at least that is what one would have concluded from the outraged headlines, like in the Washington Post (which wonders whether an extra fee for oxygen is next). The truth is, as often, a bit more nuanced: it concerns the introduction of a new Basic Economy fare which, in return for being cheaper, comes with several restrictions, including the fact that only one small personal item can be carried in the cabin free of charge.
Charging for ‘extras’ has been a popular instrument with low-cost airlines for quite some time — tickets may look very cheap, but people have been paying supplements for more legroom, for priority boarding, for checked baggage, for a seat nearer the door and of course for checking in at the airport. Yet somehow our perception can get confused when we are confronted with a pricing structure that unbundles previously all-inclusive offerings.
What appears to happen is that we are shocked when we suddenly have to make a trade-off that didn’t exist before. Even if the total cost of a Basic Economy ticket, plus any surcharge for ‘hiring’ locker space would be the same as that of a standard Economy ticket, we now have to make an active choice, and worry about whether it’s worth trying to cram our possessions in a your personal item to fly more cheaply, or not.
It would be easy for a rational person to mock those who fulminate at such airline practices, but how rational are we really? It is harder than we think not to be bamboozled when it concerns spending of money or effort, even for someone who (like yours truly) deals with this kind of thing all the time, as these three stories illustrate.
Story 1: the supermarket discount
A few weeks before Christmas, the mail brought us a set of weekly discount vouchers from Sainsbury’s, a large UK supermarket chain. The first four offered £9 off every shop that exceeded £60 in value, and the final two offered a £12 discount (again provided the total came to more than £60). The first thing you do is work out the actual percent discount — 15% for the first set of vouchers 20% for the final two, no less!
Did I say ‘no less’? That should actually have been ‘no more’ — that percentage only applies if you spend exactly £60, and the actual discount reduces with every penny over £60: at £90 the 15% discount has shrunk to 10% — still not bad, but not quite the figure that had anchored itself in my mind.
Now I like to think I have perfected the art of mentally totting up my purchases, so I was sure Sainsbury’s wouldn’t have me falling for their trickery. I was only going to buy things I’d buy anyway, and I simply made sure that my total bills throughout were as close to £60 as was reasonably possible. This way I would extract the maximum value at no cost to me.
Nevertheless, towards the end of the promotion, I suddenly realized I might not have been as rational as I imagined. In the absence of a promotion I do the ‘weekly’ shop every other week, but with the promotion I had to make an extra shopping trip to ‘save’ £6 (or £9). In other words, every second week that ‘free’ £6 (or £9) had cost me (a) the fuel to drive to the store (about 50p), (b) about an hour of my time (I am a very efficient shopper), and © the effort involved. Admittedly, the weekly shopping trips were a bit shorter than a two-weekly one would have been, but what it pretty much boils down to is this: would I be willing to go shopping for an hour for £5.50, well under the minimum wage? We both know the answer.
Story 2: the wrong mental account
Anchoring played a minor role in my irrational shopping behaviour, but it takes centre stage in other situations. Most people now have a smartphone or tablet, and are familiar with apps that are often free of charge, or priced at a few pounds at most. This has completely reset the price benchmark for software — graphics or music programs for PCs with a typical price tag of several hundreds of pounds now look expensive as an app, if they cost even as little as £10.
A few years ago I agonized for several days before splashing out on a music app, priced at £14.99. Why did I find it so hard to part with such a modest amount of money? Simply because in my mind the anchor for apps is pretty close to zero.
I could of course have compared it with other types of expenditure — the price of four coffees, or a couple of cinema tickets. But we tend to divide up our spend in categories, something Richard Thaler calls mental accounting: different budgets for, say, snacks and for ordinary food, or for clothing and for accessories. This helps us make sense of the baffling complexity of the world around us in the same way that the menus of Chinese and Indian restaurants simplify the presentation of the choice by categorizing their dishes according to the style or the main ingredient.
Unfortunately it can also reduce our overall welfare. If we use the wrong benchmark, something may look expensive and we may decide not to buy something that could well have provided us with tremendous value, much higher than its price.
A prime example is that of specialist books. In the age of the e-reader, much like smartphone apps did for the price of software, we have got used to very cheap (or even free) books, so one that is priced at £40 looks ridiculously expensive in comparison. But if it is a work that is useful for your work, which represents several thousands of pounds each month, isn’t that the wrong reference point?
A rational agent would quickly work out that such a book would need to save at most a couple of hours in a year to pay for itself — that’s an efficiency improvement of just 0.1%. If it’s not capable of achieving that, it’s obviously not worth buying, and otherwise it is really a no-brainer. Yet is that how I view pricey business books? We both know the answer.
Story 3: the relative detour
A special instance of anchoring is where we consider discounts in comparison with the full price, rather than in absolute terms. Dan Ariely illustrates this in Predictably Irrational with a reference to a Kahneman and Tversky study: most people would happily walk 15 minutes to buy a $25 pen for $18, but would not remotely consider making the same trip to buy a $455 suit for $448. This is despite the fact that the absolute advantage would be exactly the same in both cases: 15 minutes of their time in return for a saving of $7.
But we look at it in a relative way, and that determines our behaviour. And this is true not just for the financial advantage, but also for the effort involved.
Recently the same supermarket that was so generous with its shopping discount vouchers earlier on also supplied us with a fuel discount of 8p/litre. A rational person would of course be careful (a) to maximize the benefit by only using it when the tank was nearly empty and (b) to avoid making a large detour to fill up. But what is large?
You guessed it: it’s all relative. I found myself avoiding making a 2 mile detour to the petrol station on a 10-mile trip, and instead timing the refuelling so that it coincided with a 150-mile journey. The same 2 miles felt like a costly add-on (both in time and in fuel consumption) in the first case, but appeared utterly negligible in the second one.
The upside of irrationality
Much of what is sometimes regarded as irrational is nothing of the kind — often the focus of critics is on economic or financial costs and benefits, and immaterial advantages are overlooked. But the decisions in the examples above arguably do lead to lower welfare than would otherwise be the case, and so they could legitimately be termed as irrational.
However… Perhaps there is still an upside: for anyone with an interest in human behaviour, such instances provide both fascinating insight and entertainment — even if it is at the expense of one’s own overall welfare. If some friendly genie were to offer me the chance of becoming entirely rational, never again to make an irrational decision, would I take it? I probably wouldn’t.
But what would a rational person do?
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Originally published at koenfucius.wordpress.com on January 13, 2017.