We have seen the role of expected values as a rational means of making decisions. Or the expected utility in other cases. But life is not as simple as in the case of a textbook example. And life never presents situations such as betting on a number of a die or an 80% chance of $45 vs a sure-shot $30, where someone can estimate the value arithmetically. It gives options on products with price tags. But how the value of a product is visible to the decision-maker?
The author, Dan Arie, discusses this dilemma and concludes that most humans like to have a reference and use a value based on relativity. Be it the price of a meal or television – we need something to relate to before choosing an option. And the sellers know that very well and try to use it in pricing their products. Here is one possible example I encountered this morning – the subscription offers of The Atlantic magazine.
Select your plan
First, the big picture: here is what you see on the website:
There are three options: online, online + print and online + print + something else! We shall come to that something else sometime later. Imagine if the choice was between the two options, digital and digital + print:
As seen in various studies, the aspiring subscriber makes a comparison a may go for the second most expensive option. She may further justify her action for the online version as a new way of working in the digitalised world.
It is more expensive – thrice the difference between the first two
Visibly distinct – three-digit whole number vs two-digit factions with deception (e.g. 79.99 sounding 70 instead of 80)
It has repeated mentions of the word ‘free’: likely a lure for the emotional few.
Let’s do a few hypothetical calculations to demonstrate the expected value (to the seller).
Case 1: two options – 80% for option 1 and 20% for option 2. The seller’s earnings per subscription = 0.8 x 80 + 0.2 x 90 = 82.
Case 2: three options and no ‘free’ – 60% for option 1 and 40% for option 2. Earnings per subscription = 0.6 x 80 + 0.4 x 90 = 84.
Case 3: three options and ‘free’ – 60% for option 1, 30% for option 2 and 10% for option 3. Earnings per subscription = 0.6 x 80 + 0.3 x 90 + 0.1 x 120 = 87.
Dan Ariely, Predictably Irrational
