Sunday, January 30, 2011

Relativity in Our Mind

Stumbled upon a celebrated behavioural economics study conducted by Amos Tversky and Daniel Kahneman (father of BE and one of my intellectual gurus these days) today. It goes in the following manner. Suppose you have two errands to run today. The first one is to buy a new pen, and the second one to buy a suit for work. At a stationery store, you find a nice ‘Cross’ pen for Rs 1,200. You are set to buy it, when you remember that the same pen is on sale for Rs 1,000 at another store 15 min away. What do you do? Do you decide to take the 15-min trip to save Rs 200? Most people faced with the dilemma say that would take the trip to save the Rs 200.

Now you are on your second task: you are shopping for your suit. You find a luxurious grey pinstripe suit for Rs12,000 and decide to buy it, but then another customer whispers in your ear that the exact same suit is on sale for only Rs 11,800 at another store, just 15 minutes away. Do you make the second 15-minute trip? In this case most people say that they would not.

But what is going on here? Is 15 minutes of your time worth Rs 200, or isn’t it? In reality, of course Rs 200 is Rs 200- no matter how you count it. The only question you should ask in this case is whether the trip across the town, and the 15 minutes it would take, is worth extra Rs 200 you would save. Whether the amount from which this Rs 200 will be saved is Rs 1,200 or Rs 12,000 should be irrelevant.

Yet most of us would choose to value Rs 200 discount on the pen more than the same amount of discount on a more expensive item. Behavioral economists have a name for this irrationality- its called ‘Relativity’. What it means is that our decisions are influenced by the context in which they are taken. In our example Rs 200 discount on the pen looked attractive because the amount is significant relative to the price of the pen. Whereas the same amount of discount is insignificant relative to the price of the suit (16.7% and 1.67% discount for the pen and suit respectively).

This is also why it is so easy to add Rs 2,000 to a Rs 500,000 wedding catering bill, when the same person will clip coupons to save Rs 40 on a Rs 250 medium Papa John pizza. And also for the same reason your happiness is not a function of how much you earn rather it is a function of how much your wife’s sister’s husband make (apparently there is a theory that has spotted this particular relationship metric!!).  It was for good reason, after all, that the Ten Commandments admonished, “Neither shall you desire your neighbour’s house nor field, or male or female slave, or donkey or anything that belongs to your neighbour”. This might just be the toughest commandment to follow, considering that by our very nature we are wired to compare.    

1 comment:

  1. this is word for word the writing of Dan Ariely in 'Predictably Irrational'