What is Behavioral Economics?
When existing Mercedes car owners go back to buy another Mercedes,
they pay $7,000 more for the same car as first-time buyers. Why
is this? Read the explanation of "confirmation bias"
below to understand the phenomenon.
Recent research shows we aren't nearly as rational as we think.
Behavioral economics is a relatively new science that studies
how and why people make money-related choices. Here are some
of the things the studies have shown thus far.
If you bought tickets to the opera for $100, and you lose
them on the way there, would you buy another set for another
$100 if you had the money? Most people say no when asked this.
Second scenario: You're on your way to the opera, planning to
buy the tickets there, and you lose $100 in the street on the
way. You still have enough money for the tickets, though, so
do you continue with your evening's plan and go to the opera?
Most people answer yes to this scenario.
Scientists in the field of behavioral economics call this
"mental accounting." In the first scenario, you already
spent $100 from the mental category "opera," so it
seems too expensive to spend another $100. In the second scenario,
you lost $100 cash - a separate category. It's easier to buy
the tickets still, even though in both cases the financial situation
is absolutely the same. This kind of "mental accounting"
has its consequences, and you'll see it at work in some of the
other tendencies explained below.
We are more likely to attend an event if we pay for the ticket
than if we get it free, even if the information and interest
are the same. Money, once spent, logically has no relevance to
the decision, yet the tendency persists even when pointed out.
Most of us would feel worse throwing away a ticket we paid for,
Applications are obvious, if you look. For example, rather
than giving away tickets to "get rich" seminars, organizers
would get better attendance by selling their "$100"
tickets for $3. Simply paying something makes people more likely
People act economically in a way that confirms their current
beliefs. For example, when negotiating to buy the exact same
model of Mercedes, current owners, who presumably believe in
the value of a Mercedes, pay $7,000 more, on average, than new
Mercedes customers. You can imagine the value of this knowledge
to companies that sell high-priced items.
A study showed that customers bought twice as often when given
four samples of jam to taste than when they had twenty to choose
from. It seems that having too many choices leads to an inability
to decide. Offering limited options may be a useful sales technique,
according to this research finding.
We instinctively avoid extremes, according to the research.
With a choice of televisions costing $300, $500, and $700, for
example, not many buy the $700 one. But add a $1200 television
to the choices, and more will then buy the $700 one, because
it is no longer the most expensive one.
The law: A change of stimulus is more emotional and motivational,
according to the base: Subjects tested would drive across town
to save $10 on a $20 item, for example, but not to save $10 on
a $500 item. For sales people, this means you probably won't
lose a sale on a thousand-dollar couch over $10, so forget dropping
the price and sell the other benefits.
Note: Some who study behavioral economics go beyond
just looking at what people do. On my personal blog I have an
interesting post on monkey prostitution (yes, you read that right).