Behavioral New World
November 1, 2023
Anchors away!
Recently I was searching for airline tickets for an international trip. I was perusing several well-known travel websites. There wasn’t any urgency, so I checked every day or two. The price for an Economy seat was about $3000, consistently across travel websites and airlines.
Then one day I saw one for $2000. It was shown on a reputable travel site, and I could find it on the (reputable) airline’s website. Any lingering skepticism I had vanished when the travel website’s analytics said that this fare was abnormally low. I bought the ticket and felt good about the purchase.
After my $2000 Economy purchase, I was curious about how much more Premium Economy would cost. Answer: around $5500. Once again, I felt good, at least temporarily: Given the length of the long-leg flight, I was paying myself almost $100 (after tax!) per hour for sitting in Economy. A reasonable choice, it seemed.
But later the following thought occurred to me: What if I never saw the $2000 Economy fare and I bought a ticket for $3000? Would have I considered upgrading to Premium Economy?
Maybe. After all, the additional cost for Premium Economy would have been $2500. Given my bargain fare, the additional cost for Premium Economy was $3500. So if I had paid more for my Economy fare, I would be more likely to upgrade to Premium Economy, which seems rather odd.
Hmm… Behavioral economics has a name for this phenomenon: anchoring.
This narrative is not a conventional anchoring story (two examples below). In this case, the $2000 became a reference point for the difference in fares between Economy and Premium Economy. One might call it Differential Anchoring.
Note: This narrative is not to be confused with the decoy effect, the subject of a future newsletter.
Let’s consider two more conventional anchoring stories. The first is the stereotypical used car salesman. You’re at the dealer, find a car you like, and ask the price. “$25,000,” he says (all stereotypical used car salesmen are men). That becomes the anchor for the negotiation—you will feel good about getting it for less than $25,000 because the opening salvo anchored you on $25,000. Many types of negotiations (salary, house price, garage sales near the end of the day) involve anchoring.
Another example, this one from finance: The price you pay for a stock becomes an anchor. This reference point is especially germane if the current stock price is less than you paid. With the purchase price as the anchor, the investor says, “I’ll sell it when it gets back up to what I paid for it” (sound familiar?). But what you paid for it is a sunk cost (see the April 2022 newsletter) and thus irrelevant. Your fixation on the purchase price gets in the way of rational decision-making about whether to sell.
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Anchoring can be a tool in a lot of persuasive situations (not just car sales and not just price). If you have a great plan, you often want to be the first to present it, as then all others will be compared to it. You don't want to wait until the crowd has anchored on another idea. It depends on the situation, but if you are trying to convince someone to "buy" your idea or car, you want to get something for them to anchor on out there quickly.