Think about two scenarios that could (and probably, with some variation, will) happen this weekend. In the first scenario, Joe goes to the store and buys the dining table and chairs he needs for his new apartment. The regular price of the set is $1,400, but it is reduced by 50% this weekend — to only $700. What a bargain! In the second scenario, Steve goes to a different store, buys the identical dining set, and pays that retailer’s regular price: $600.
Which buyer will be happier with his purchase: Steve, who paid $600, or Joe, who paid $100 more? As a behavioral economist, I’d place my bet on Joe (provided Joe and Steve aren’t aware of each other’s purchases). If you go shopping this weekend, you’ll discover that retailers are also betting on this puzzling consumer behavior. Why would a customer who paid more for his purchase be happier than one who paid less? A couple of psychological explanations are possible.
The first is called the contrast effect. You can try the following fun experiment at home: put your left hand into a bucket of ice water and your right hand into a bucket of warm water. Leave both hands in the buckets for about a minute. Then immerse both hands into a third bucket filled with lukewarm water. It’s worth a try; the feeling is really weird. Both hands are in the same bucket, but they feel quite different. The left hand, which was in cold water before, feels warm. The right hand, which was in warm water, feels cool. Although you know both your hands are in the same bucket, each of them sends a different signal to your brain.
The same is true when you buy something that is deeply discounted from its original price. Joe paid $700, which is substantially less than the initial $1,400 price tag. Steve? He wasn’t lucky; he simply paid the asking price of $600. Our brain is really great at comparing initial and final prices, but it is not as good at thinking in absolute terms.
The second psychological reason consumers are often happier paying more is that they tend to believe that price equals quality. Many times it does; higher-priced items are of higher quality. But sometimes retailers can use high prices to trick us: the higher price of Joe’s table led him to believe it was “worth” more than what he paid.
This psychological trick works especially well with products and services for which quality is subjective, or tough to evaluate. Think of the following: it’s your anniversary and you want to bring home a nice bottle of wine to celebrate. Typically you drink wine that costs about $20 a bottle, but today is a special occasion, so you go to the store and look at the $50 bottles. You don’t have a specific wine in mind: you just assume a $50 wine tastes better than a $20 wine.
How do retailers use this effect to their advantage? In our recent book, The Why Axis, John List and I describe a field experiment I ran with Ayelet Gneezy and Dominique Lauga in a winery. The owner of the winery — let’s call him Matt — asked for our help in pricing his new cabernet sauvignon. We jumped at the chance — apart from being fun to drink, wines are also fun to price.
Visitors to Matt’s winery taste different wines and subsequently choose to buy from the selection. The cabernet sauvignon we used to test the effect of prices on people’s decisions was a “prodigious wine, with complex notes of blueberry pie, black currant liqueur, acacia flowers, lead pencil shavings and sweet foresty floor notes.” The price Matt had previously chosen for it was $10, and it sold reasonably well.
In our experiment, we manipulated the price of the cabernet to be $10, $20 or $40 on different days over the course of a few weeks. Each day, Matt greeted the visitors and told them about the tasting. Then visitors went to the counter, where they met the person who administered the tasting and gave them a single printed page containing the names and prices of the nine included wines, ranging from $8 to $60. After tasting the wines, visitors decided whether to buy any of them.
The results shocked Matt. Visitors were almost 50% more likely to buy the cabernet when it was priced at $20 than when it was priced at $10. That’s right — when we increased the price of the wine, people liked it more, and in some cases, were even more likely to buy it.
As consumers, we should be aware of our tendency to make purchase decisions based on cues that lead us to believe we are getting a good deal (see Joe vs. Steve) or a high-quality product (if the price is high enough). It might be useful to consider the items you want to purchase in absolute terms. Going back to the dining-table example, Joe would be better off asking, “Do I need this dining table? If so, is it worth $700 to me?” and by not allowing himself to be distracted by the very tempting, but often not so relevant, information regarding the original price, discount depth and so on.
And, of course, if you want to buy The Why Axis, you can simply send me a check for the full price. Or you can buy it on Amazon.com. I hear they have a great sale on it!
Uri Gneezy is the Epstein/Atkinson Endowed Chair in Behavioral Economics and professor of economics and strategy at the Rady School of Management at the University of California, San Diego. He is the co-author, with John List, of The Why Axis: Hidden Motives and the Undiscovered Economics of Everyday Life.