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Behavioral Economics In Action

Understanding the biases in our decision-making process

Photo by Brandon Lopez on Unsplash

Daniel Kahneman, a Nobel laureate in the field of behavioral economics, once remarked, “Our comforting conviction that the world makes sense rests on a secure foundation: our almost unlimited ability to ignore our ignorance”. I couldn’t agree more. Often, we cannot help dealing with the limited information we have as if it were all there is to know. We try and build the best possible story from the information available to us, and if it is a good story, we believe it. We believe that the decisions we make are correct if we feel a positive sentiment upon making the decision. Such is the illusion of understanding. Let me demonstrate with an example:

Let’s say you want to order a cake online. You go to MakeACake.co.in (a hypothetical website) and begin your search for an ultimate satiation. Assume the website follows these layouts:

Scenario #1: You get directed to a basic cake model (say a 7” round shape sponge cake with fresh cream filling) and are asked to add the decoration(s) to suit your needs. You can choose from a variety of crumb toppings, prints, fruits, hard candies, sanding sugars, and chocolates. The basic model costs you Rs. 1200/-. Each additional garnishing increases the price by a fixed amount. You add Rs. 800/- worth of edible embellishments on your cake and check out with a bill of Rs. 2000/-.

Scenario #2: You get directed to a finished cake model with all decorative ingredients mentioned above already used as a garnish over the cake. In this scenario, you are asked to remove the decoration(s) that do not suit your needs. The fully-finished model costs you Rs. 2800/-. After looking through the list, you remove Rs. 800/- worth of ingredients from your cake and check out with a bill of Rs. 2000/-.

If I ask you in which scenario did you have a more satisfying experience, what would your answer be?

If you’re like most people, you would pick the second scenario. Let’s think through why this happens.

Even though the final product and its price are same in both scenarios, you perceive the reduction of price from Rs. 2800/- to Rs 2000/- as much more satisfying than the increase in price from Rs. 1200/- to Rs. 2000/-. Since both the increase and decrease in expenditure is attributable to you making the decision, you feel a sense of happiness by reducing your potential expenditure.

I will go a step further to say that even with no knowledge of the first scenario if you had removed only Rs. 700/- worth of garnish in the second scenario, you would have still found the experience to be satisfying. This is primarily because when we look at the second scenario, we see the cake to be priced at Rs. 2800/-. This amount becomes an anchor in our minds. A reduction in this price not only makes us feel happy but it also reinforces the belief that we have made the right decision.

How about a real-life example? Let’s take magazine subscriptions. I am quoting the subscription details for The Economist (last accessed: August 9, 2018). Three types of subscriptions are on offer:

1. Digital – INR 1400 for 12 weeks,

2. Print – INR 2300 for 12 weeks, and

3. Digital+Print – INR 2900 for 12 weeks recommended as the best value offer

For someone who is not aware of behavioral economics at play here, he/she is bound to fall for the anchoring bias. Clearly, INR 1400 + INR 2300 = INR 3700. Indeed, Digital+Print is a good deal. Again, we feel happy about this decision without realizing the actual utility of what we’ve bought. Unless we really wanted to buy both Digital and Print, we could have easily subscribed to either Digital or Print based on our preferred choice of medium!

Imagine for instance that there was no Digital+Print choice available in their subscription offer. Would you have selected Print over Digital? Maybe, if you are an offline reader. But think of this – Your satisfaction would definitely be more in the case where you had selected Digital+Print because of the anchoring effect of INR 800 saved than when you chose Print over Digital because of INR 900 paid extra.

It is interesting how we perceive choices relative to each other, and how paying more can sometimes make us happier than paying less! As it would have been evident by now, framing plays an important role in our decision-making process, which, in turn, affects our psychological well-being.

We can actively be on the lookout for biases like these. There are plenty around us!

Have a great week!

Originally published at www.linkedin.com

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