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Predictable Irrational

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July 31, 2009 – Comments (6) | RELATED TICKERS: UPS , E , LL

I stumbled upon this little excerpt from the book of the same title by Dan Ariely, and thought you all might find it interesting;

 

Consider this: if I asked you for the last two
digits of your social security number (mine are 79), then asked you whether you
would pay this number in dollars (for me this would be $79) for a particular
bottle of Côtes du Rhône 1998, would the mere suggestion of that number
influence how much you would be willing to spend on wine? Sounds preposterous,
doesn’t it? Well, wait until you see what happened to a group of MBA students
at MIT a few years ago.

“Now here we have
a nice Côtes du Rhône Jaboulet Parallel,” said Drazen Prelec, a professor at
MIT’s Sloan School of Management,
as he lifted a bottle admiringly. “It’s a 1998.”

At the time, sitting before him were the 55
students from his marketing research class. On this day, Drazen, George
Loewenstein (a professor at Carnegie
Mellon
University),
and I would have an unusual request for this group of future marketing pros. We
would ask them to jot down the last two digits of their social security numbers
and tell us whether they would pay this amount for a number of products,
including the bottle of wine. Then, we would ask them to actually bid on these
items in an auction. What were we trying to prove? The existence of what we
called arbitrary coherence. The basic
idea of arbitrary coherence is this: although initial prices 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”). So, would thinking
about one’s social security number be enough to create an anchor? And would
that initial anchor have a long-term influence? That’s what we wanted to see.

“For those of you who don’t know much about
wines,” Drazen continued, “this bottle received eighty- six points from Wine Spectator. It has the flavor of red
berry, mocha, and black chocolate; it’s a medium- bodied, medium- intensity,
nicely balanced red, and it makes for delightful drinking.” Drazen held up
another bottle. This was a Hermitage Jaboulet La Chapelle, 1996, with a 92-
point rating from the Wine Advocate magazine.
“The finest La Chapelle since 1990,” Drazen intoned, while the students looked
up curiously. “Only 8,100 cases made . . .”

In turn, Drazen held up four other items: a
cordless trackball (TrackMan Marble FX by Logitech); a cordless keyboard and
mouse (iTouch by Logitech); a design book (The
Perfect Package: How to Add Value through Graphic Design); and a one- pound
box of Belgian chocolates by Neuhaus.

Drazen passed out forms that listed all the
items. “Now I want you to write the last two digits of your social security
number at the top of the page,” he instructed. “And then write them again next
to each of the items in the form of a price. In other words, if the last two
digits are twenty- three, write twenty- three dollars.”

“Now when you’re finished with that,” he
added, “I want you to indicate on your sheets-with a simple yes or no- whether
you would pay that amount for each of the products.”

When the students had finished answering yes
or no to each item, Drazen asked them to write down the maximum amount they
were willing to pay for each of the products (their bids). Once they had
written down their bids, the students passed the sheets up to me and I entered
their responses into my laptop and announced the winners. One by one the
student who had made the highest bid for each of the products would step up to
the front of the class, pay for the product, and take it with them.

The students enjoyed this class exercise, but
when I asked them if they felt that writing down the last two digits of their
social security numbers had influenced their final bids, they quickly dismissed
my suggestion. No way!

When I got back to my office, I analyzed the data. Did the
digits from the social security numbers serve as anchors? Remarkably, they did:
the students with the highest- ending social security digits (from 80 to 99)
bid highest, while those with the lowest- ending numbers (1 to 20) bid lowest.
The top 20 percent, for instance, bid an average of $56 for the cordless
keyboard; the bottom 20 percent bid an average of $16. In the end, we could see
that students with social security numbers ending in the upper 20 percent
placed bids that were 216 to 346 percent higher than those of the students with
social security numbers ending in the lowest 20 percent.

6 Comments – Post Your Own

#1) On July 31, 2009 at 10:17 AM, outoffocus (23.09) wrote:

I think this study is flawed. First, this study assumes that everyone has the exact same amount of resources, which in 99.9% of cases that is not the case. What keeps me from buying that red wine? The fact that I can't afford it. Second, the professors did not allow people to effectively compete with each other in price, which is what happens in the real marketplace.  If I see a product that I want to real bad, and I know someone else is willing to pay x price for it, knowing that I will either pay x+ for that item or I will back off due to lack of resources.  Third, when someone wants to buy an item, isnt their first reaction to ask what the price is, rather than write down some arbitrary number on a piece of paper?

So although I respect the professors efforts,  when compared to real world economics,  I really don't think this study proves much.

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#2) On July 31, 2009 at 10:25 AM, TMFFlightsuit (< 20) wrote:

Thanks for the post, Devoish.

We were lucky enough to host Professor Ariely at Fool HQ not too long ago. He's certainly one of the foremost academic experts working on the blend between cognitive psychology and economics. I'm a big fan.

If you enjoyed the article above, you might appreciate this as well:

http://www.fool.com/investing/general/2008/10/07/when-credit-default-swaps-meet-office-supply-swipe.aspx?terms=dan+ariely&vstest=search_042607_linkdefault&mrr=1

Nick

 

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#3) On July 31, 2009 at 10:25 AM, cthomas1017 (96.29) wrote:

Great post!  No wonder I'm so darned frugal.  The last two digits of my SSN are below 20.  My wife's are '95'.  This explains everything! ;)

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#4) On July 31, 2009 at 12:04 PM, devoish (98.26) wrote:

cthomas1017,

I'd hate to be at your house selecting a restaurant. :-)

outoffocus,

Of course the study is flawed.

1st) The people with the greatest buying resources could easily have been among the lowest bidders with the lowest SSI numbers.

2) The test eliminated the outside influence of what others might do and focused just on the presence of a randomly selected price point, well known to have no connection to the actual value of the product.

And yet their offers were influenced by that randomly selected price point.

3rd) When you want to buy something, if you can be influenced by a number you know is not relevant, why would you ask the price and possibly get the sellers SSI number as a guide?

This reminds of a Mexico vacation where we went shopping in a tourist trap near Ccozumel. My wife and daughter wated to buy two silver rings as gifts for friends. The Mexican in the booth told us that the rings were $80.00 each. I negotiated him down to $10.00 each and bought them.

Back at the hotel similar rings were in the gift shop marked at $5.00.

I am a case study. Sigh....

Nick,

Thanks for the link.

 

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#5) On July 31, 2009 at 12:34 PM, StopLaughing (< 20) wrote:

All studies are flawed. However there is something to reference price theory. I recently published a paper on gasoline prices (using a different flawed methodology). Reference prices appear to be related to equity theory and perceptions of fairness in pricing.

At this point the reference  prices for the stock market are some place between 8,000 and 14,000 on the Dow. The average would be about 11,000.  I am not sure most of the individuals with the purchasing power think in terms of averages? However, where we are now is still on the low side of average for the last 10 years or so. 

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#6) On August 03, 2009 at 5:36 PM, toopersent (80.69) wrote:

I am a case study. Sigh....

 

Ah, the same happened to my father and I.  I rencently got back from Mexico.  At the resort, there was a fellow selling a box of 10 Cuban habneros (cigars). He wanted $60, we talked him down to $35 and walked away giving each other high fives.

A few days later, I see the same box of cigars in a cigar shop for $20!  WHAT A JERK!

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