The Rational Defeat of Economics

As a graduate in economics honors, I wonder what exactly is economics? Those complex models and those mathematical equations which can spur out anyone’s mathematical anxieties or those graphs which claim to predict human behavior through lines? To us, economics is nothing but an understanding of human’s rational behavior both at micro (microeconomics) and Macro (macroeconomics) level. But, Is our behavior so complex? And are we are all rational after all?

If Yes, then what is rational?

Rational is to think in a reasonable fashion and to decide among things. A rational way of thinking might have other assumptions lying beneath it. Those assumptions are nothing but notions of your subconscious brain which might influence your decisions without you even noticing them.

One of the basic concept in economics is of utility and how humans derive utility from things and thus decide their worthiness. This is the reason why you don’t want to eat another chapatti after having 4 of them or why companies offer bulk discounts, taking into account as you consume a good it’s marginal utility to you decreases consecutively and finally even turns negative.

But what about those pair of jeans that you might think is cheap but your friend thinks is hell expensive even after a discount? Now this is governed by what is so called Price- Anchors. Whenever you buy something for the first time or first few times, you set an anchor for the price that you might be willing to pay for that thing. Now whenever you buy that item, that price anchor will decide whether you think you are getting a good deal or not. Price anchors take time to get revised but over a period of time they can change due to many reasons. Have a look at avid Online Shoppers in India. E-commerce companies give away huge discounts thus revising the anchors for almost all of us. The discounts which were earlier given to incentivize people to buy things online has led to people expecting discounts on everything. Price anchors can also be relative which could happen when you first bought a pen and expected it’s price from the price of the pencil you have been buying.

But what happens if you buy something or the first time?

Quoting an example from the book “predictably irrational”, Dan Ariely experimented to make a new market for sound. In the experiment, some people were asked to pay some amount for listening to a sound and some were given some money to listen to the same sound. Since there was no preexisting market for the same, people were later asked how much were they willing to pay or receive for listening to that sound accordingly. People who were told they were to pay for that sound happily paid (and gave a price for it) and those were told they will be receiving some money in return happily accepted money for the same sound.

Now for this new market there were no price anchors in the minds of people but after some time when people were expected to play a part in developing a market, it is heavily influenced by the situation that a person is in and not what is so called “Rational”.

But what is all this economics doing in a marketing blog? Well, that’s a good question!

Marketers know our limitations very well and that’s why they use it to define a niche market space for themselves to demand “Rationally Unreasonable” amount for their products. As that niche market space slowly swells with more brands coming in with the same features that made it ‘niche’, the prices drop and the market no longer remains niche.

An experiment was done which required people to collect 8 stamps for a car wash and stamps were given to people who purchased products over a certain amount. Now, there were 2 sets of people, one were given the task of completing 8 stamps and the other was given the task of completing 10 stamps but 2 stamps were given default. At the end of the study, it was noted that people who were given 2 stamps were more willing to complete the task of collecting all the stamps as compared to the other group. At the heart of this example is our tendency to complete tasks which are semi-complete over those tasks which need to start afresh. Using this technique, marketers tend to drive action by completing a part of the action by default. For Example Chances of getting a form completed when it says “50% complete” by default is more than if nothing is said about the default completion.

Since a long time marketers have been using Behavioural Economics to make consumers make choice in the firm’s favor without even realizing. The next example comes from a well-known practice among the restaurants in the United States. In the States, restaurants which see a decreasing sales volume for their most exclusive and eloquent dishes (and obviously the most expensive dishes on their menu) introduce a few dishes more expensive than the dishes in question to act as a decoy. Here these decoys do nothing to get chosen by the customers but present them with a benchmark to compare prices to.

We know that whenever humans are faced with choices we require things to compare, for making a decision. Thus companies sometimes provide a decoy just to drive demand for the product in question. As far as our restaurant example is concerned the restaurant saw an increased demand for that eloquent dish just by introducing some more expensive dishes. So the problem was not that people didn’t want to buy those dishes in question but didn’t want to buy the most expensive ones on the menu. Similarly, companies introduce different screen size models for TVs just to drive demand for some specific sizes. Ever wondered why everyone seems to prefer 32 inch TVs more than any other size? Maybe the companies just wanted so.

Thus, while economics lays down rules for a rational behavior, marketing uses the same to sell things to us.

In Economics, we have studied the basic principle of demand and price for normal goods. More the price, less the demand and vice-versa. That is very well true but only when you buy things using money. What do I mean? No, we are not going back to barter system but studies suggest that people experience pain similar to physical pain while they have to pay money for buying things. Probably that’s the reason why we men don’t like to go shopping. But this physical pain points can be avoided by introducing a secondary method for transactions. Ever wondered why amazon gives away discounts on use of credit cards? Or Virtual Games demand virtual coins to be purchased first which could further be used to buy in-app features and items. Similar to the restaurant example, menu’s which don’t have currency placed next to the price of items get more orders and of higher per order value than those who do.

But can we demand money and still make it sweeter? Apparently Yes.

IKEA, which is the leading Swedish home furnishing company, sells furniture in pieces which have to be put together by the consumers, which might seem cumbersome at first but as the story rolls out it isn’t. The entire idea of IKEA is to get consumers to make their own furniture and add a sense of emotional attachment to it. The same strategy is used by a lot of firms including customizing t-shirts and cups etc. This way the consumers have a sense of belonging and ownership with the product and thus the products get valued more. This is popularly known as the IKEA effect. Similar to this effect is the endowment effect which makes consumers value items they own more than item owned by someone else. This gives rise to what is called “Cognitive Dissonance” or “Buyer’s Remorse” which drive people to second their own choices made in the past even though their opinions and tastes might have changed.

Thus, Challenging the Assumption of Rationality in Economics is as difficult as defining Rationality itself. It is imperative for us to understand that it is not about defeating the models of rationality but to evolve them to make people understand economics in a more holistic manner. Inviting opportunities to revoke the assumptions will help us understand economics better as economics is nothing but an understanding of human behavior and no one can challenge it but us.