Psychology in Market
By Aman Yadav
It has been a belief that rational people make rational decisions. This belief system has generated an entire rational choice theory, which says that people employ logical calculations to make sensible decisions and obtain outcomes that are in line with their own personal goals. This concept has also been the main assumption in most of the economics that we study. But do you really think that people make rational decisions every time?
Suppose a particular smartphone is available in the market for ₹25,000. Your friend buys that smartphone at the same price. You enquire from your friend about the price and features of the new phone. After listening to the features, you are also tempted to buy it. Your friend tells the price of the phone to be ₹25,000. Now suppose the price of the smartphone drops to ₹20,000 but you are not aware of this change. You go on to buy it in a phone store and the shopkeeper offers it to you at ₹22,000. And you buy that phone without enquiring about the price at some other store nearby. Do you believe this to be a rational decision? Therefore, there is also a different school of thought that believes that all the decisions of a person are not rational. Why do you think this happens? Let’s have a look at the reasons for this.
Firstly, there can be barriers to information i.e., information to make the right kind of decision may not be available. Even if it is present, it may not be accessible to people or may require too much effort and resources to collect. Secondly, there may also be limitations to the ability of the people to conduct an analysis of competing choices with the available information. The latter happens a lot in financial markets.
The third reason is explained by the interplay of the human mind, behaviour and emotion in the market. In the example above you could have saved ₹2,000 more if you would have visited a few more stores to enquire about the smartphone. But you did not do so because you came with the expectation of purchasing it at ₹25,000. The moment you were offered ₹3,000 less than your expectation you were tempted to buy it.
So, the third reason can be summed up as human psychology affecting decision making. For instance, the Netflix show “The Queen’s Gambit” depicts Beth Harmon, a chess prodigy who struggles with drug addiction, conquering a male-dominated chess world. This inspired people especially the women and led to the development of chess interests among people. There was a surge in registrations on online chess playing platforms like chess.com and also the chessboard sales skyrocketed.
The power of psychology is dominant in the market. There has been a lot of study in this field and psychologists and economists have come up with various biases that people keep in their mind but never pay attention to. These biases impact the decisions of people. There are innumerable biases but for now, we’ll be having a look at some of the dominant ones.
The above example of the smartphone was of anchoring bias. Your first impression of the price was that the smartphone is of ₹25,000. This price was fixed or anchored in your mind and the subsequent decision was influenced by this first piece of information which you took as a reference point (anchor). So, when you were offered ₹22,000, you compared it to the anchor and found it to be less than that, leading your mind to believe that you were getting a better deal on the smartphone.
So, anchoring bias is one which causes an individual to rely too heavily on the first piece of information he/she receives about any particular topic and the individual’s decisions are influenced by that reference point also called the anchor which is set in their mind.
Now think of Starbucks. Before its arrival the price of coffee anchored in the minds of people was quite less. Then how did this coffee giant succeed in selling coffees at such high prices. Though it might seem to be a contradiction to the anchoring bias, it is not. In fact, it is an instance of successful use of this bias to establish itself. The experience that Starbucks provided was so vast, enriching and different that people did not compare the Starbucks coffee to the normal coffee they had been drinking. This made people forget the previous anchor of cheaper coffees. Dan Ariely writes, “Starbucks did everything in its power to make the experience feel different — so different that we would not use the prices at Dunkin Donuts as an anchor, but instead would be open to the new anchor that Starbucks was preparing for us.” As a result, a new anchor price was created for the entire experience, not just the coffee.
Try remembering any 5-7 movies that you have watched. If you observe this list carefully you will find that most of these movies are the ones which you have seen in the past 1-2 years. This is because of the fact that you are easily able to recall or remember those items that you have come across recently. Recency Bias occurs in the short term as well as long term and there are different models like dual store models, single store models and Ratio rule that explains the working of the recency effect. However, the basic essence in both the categories (short term recency effect and long term recency effect) is the same that you are able to recall the latest items more easily and quickly.
As the name and example suggests this is a bias where people favour and put more weight to recent events than the historic ones. This happens a lot in interviews where your conversation of the last 5-6 minutes is given more weightage than the overall interview. Also, think of a situation when a waiter is reading out the menu to you. You only remember the last few dishes that they narrated from the menu.
Now look at this instance of Dove brand. Dove has always been known for promoting body positivity with its “Real Beauty” campaign which portrays real women in a positive light. This campaign has been very successful over the years and has been running for more than 15 years. The company aspires to assist women maintain a positive body image. However, the campaign went downhill when Dove introduced seven limited-edition bottles in May 2017 with abstract shapes supposed to resemble a range of female body shapes. The packaging sent a wrong message. This was because they only released seven distinct bottle shapes, requiring women to select the bottle that best matched their body type. So, rather than encouraging a positive body image, it increased self-consciousness. The campaign faced a lot of criticism on social media which tarnished the brand image. People forgot the past 15 years of legacy of promoting positive body image and focussed their attention entirely on this mistake of the brand criticising it for the wrong message depicted by its product. This is a typical example of recency bias. People put more weight to recent happenings rather than historic events.
Loss Aversion Bias
Let’s consider a situation where you buy a second hand laptop without inquiring much about it. The laptop turns out to be a faulty one. It breaks down quite often and then has to go through repairs from the workshop. You are spending a considerable amount of money on its repairs (the repairing cost may exceed the cost of the laptop in near future). Would you sell the laptop or continue with it? A rational decision here may be to sell the laptop because the repairing costs are not justifiable. If you buy a new laptop it may be more beneficial both in terms of convenience as well as cost. In spite of this, you continue to use the old laptop and get it repaired regularly as and when required.
This is because of the fact that people prefer avoiding losses over acquiring equivalent gains. Individuals perceive a real or potential loss to be more painful than the pleasure they get from a gain of the same magnitude. This is the loss aversion bias.
Marketing tactics like “Save 15%”, “Don’t miss out the opportunity to crave one of the finest Biryanis” etc. are examples of using loss aversion bias. “Save 15%” signifies that the consumer has the opportunity to avoid a loss. Although the offers of “Gain 15%” and “Save 15%” may mean the same financial advantage, “Gain 15%” would receive less attention than the latter. Loss aversion surpassed other cognitive biases on an e-commerce platform, according to Daugirdas Jankus’ research at the ISM University of Management and Economics, with the highest increase in conversions and the highest mean scores for maximising page views.
Therefore, although we try to make rational decisions every time there are some constraints to this. All the decisions are influenced by one or more of these biases. Companies have started to exploit these irrationalities in decision making. Although it is not easy to not let these biases affect your decisions as these occur on their own without much control of a person, their knowledge can surely help to minimise their impact. This may result in a decision that is better than the one made without the knowledge of these biases. But it goes without saying that Psychology and Markets work in tandem with the former having a great impact on the latter.
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