Economics For Business [8 ed.] 1292239271

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7.1 HOW DOES BEHAVIOURAL ECONOMICS DIFFER FROM STANDARD THEORY? 113 sometimes referred to as bo1111ded rationality. Finding and processing information takes time and mental effort and busy consumers ,nay decide it is simply not worth it. For example, in some circumstances, it maybe difficult to compare the price and quality of all the different versions of a good or service offered by different suppliers. This may become more of a problem as the range of alternatives increases. With many consun1ption decisions, there is also an ele­ ment of uncertainty about the exact size and nature of the cost and benefits. This will be particularly true for consumer durables such as laptop computers, mobile phones and TVs. For example, when pur chasing a laptop, a customer may be unsure about (a) how well it will perform, (b) how useful it will be and (c) the chances it will break down. Considerable uncertainty may also exist when booking a hotel or holiday. In these circumstances, the consumer will have to make a judgement about the likelihood of different events occurring. For example, what are the chances that a holiday resort/hotel is not as nice as it appears in the brochure or that the weather may be bad? There is evidence that people often find it very difficult to make these types of probability assessments.

Heuristics To simplify choice problems, consun1ers often revert to using mental shortcuts that save on their time and effort. These are called heuristics. For example, a study by Hoyer found that consumers spent on average 13 seconds deciding what to purchase from a super mark et aisle. The same study also found that only 11 per cent of consumers examined two or more products when purchasing detergent. To make these decisions so quickly, people typical ly use very simple rules of thumb. For example, when deciding what make or brand of prod­ uct to buy, consumers may revert to using the so-called 'halo heuristic' . This simple rule is the assum ption that, because a person or business is good at doing one thing, they will also be good at doing something else that may be completely unrelated. Therefore, if a con sumer is happy with their expe­ rience of consuming a particular brand of a product, they may choose the same brand when deci ding to purchase a different product they have never tried before. For example, if you are really happy with your SamsungTV, then you may choose another Samsung product when buying a laptop computer or smartphone for the first time. The halo heuristic generates brand loyalty and is something that companies recognise and strive to develop in their customers. Consumers can be heavily influenced by the experience of a lim ited number of friends or relatives when choosing to buy a produ ct. This is called the 'availability heuristic'and is explained in more detail in the next secti on. Usi ng heuristics often helps consumers make the best choices while also reducing the time and effort costs of care­ fully c omparing each option. However, their use can some­ times lead to decisions that differ from rational choices in systematic and predictable ways.

Behavioural economics atten1pts to identify these heuris­ tics and the systen1atic errors they sometimes cause. Under­ standi ng these m ent al shortcuts is i mportant to those working in the advertising and ,narketing industry who want to know the m ost effective ways of influencing people's spending deci sions.

Types of heuristic There are several different types of heuristic that people use. These include the following:

Choice overload or the paradox of choice. When faced with numerous diff erent choices, consumers may respond by using a very simple rule of thumb - avoid making a decision altogethe r . This results in two possible outcomes:

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Those consumers who have no prior experience of con­ suming the good fail to make any purchases, even though it would increase their utility. Those consumers who have consumed the good previ­ ously continue buying the same brand without attempt­ ing to search for other options that are better value for money. This leads to purchases with a lower consumer surplus than the alternatives.

A well-known experi ment to test this idea of choice overload was conducted by Sheena Iyengar and Mark Lepper who set up a jam tasting stall in a grocer y store. People were more likely to buy a jam when there were only six varieties availa­ ble than when there were 24. Thi s and other evidence on choice overload is discussed in more detail in Box 7.1.

The herding heuristic. Some consun1ers may use a quick deci­ sion rule of copying and in1itating the actions of others. In other words, they are strongly influ enced by what other peo­ ple pur chase. A fashi on ,night catch on; people might grab an item in a sale because other people seem to be grabbing it as well; people ,night buy a particular share on the stock mar­ ket because other people are buying it. In some circumstances, the herding heuristic may be a good decision rule as other people have better information about the quality of the good or service. However, in some situations, other consumers may not have superior informa­ tion. They star t buying the good because many other people have. Sales soar and prices may be dri ven well above a level that reflects the utility people end up gai ning.

LDefinitions Bounded rationality When consumers have limited abilities to find and process the rel evant information required to make the best decision, i.e. purchase the goods th at gene rate the most consumer surplus. Heuristic A mental shortcut o r rule of thumb that peo­ ple use when trying to make complicated choices. They reduce the computational and/or research effort required b ut somet imes lead to systematic er ror s.

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114 CHAPTER 7 BEHAVIOURAL ECONOMICS OF THE CONSUMER Theanchoringheuristic. This is a tendency for consumers to be overly influ enced by the first piece o f information they see, even if it is unrelated to the decision. In one famous pieceof research byTversky and Kahneman1 the participants in an experiment first spun a wheel that randomly generated

BOX7.1

a number between O and 100. They were then asked how many African countries were in the U N . The par ticipants :sA .1\rersky and D .Kahoem a n, J' udgment u11 der u11cert aioty: and Biases',Scle,1c,, Vol 185 (1974), p p . 1124 -31.

Heuristics

CHOICE OVERLOAD

Is more choice always a good thing for consumers? According to standard economic theory, more choice is a good thing for the consumer. It helps people find products and services that increase and maximise their utility. However, results from a well-known field experiment conducted by Sheena Iyengar and Mark Lepper' suggest that, in some circum­ stances, too much choice might hamper effective decision making. To test this idea, the researchers set up a jam tastin g stall in a supermarket in California: i.e. in an environment where consumers typically make choices.Every few hou rs, they switched the n umber of different varieties on the stall from 6 to 24 and back again. No popula r flavour s such as straw­ berry were ever included. As shoppers walked by, they were invited to sample the different jams. After a visit, shoppers were given a $1 discount vouche r towards the purchase of any of the jams they had tasted. The expe riment was designed so tha t the usage of these vouchers could be tracked to see if the shoppers who visited the stall when there were 24 varieties of jam were more likely to use their coupons than when there were 6 and vice versa. The study produced the following results:

■ Shopper s were more likely to visit the stall and taste the ■ ■

jams when 24 varieties were displ ayed. This suggests that consumers initially find the thought of more choice appealing. The average number of different jams tasted remained the same, no matter how many varieties were displayed. Inter­ estingly, no consumers tried more than two different flavours. Approximately 30 per cent of the shoppers who visited the stall when there were 6 different varieties of jam used the vouchers as opposed to just 3 per cent who visited when there wer e 24 .

The same authors also carried out a laboratory experiment (i.e. in an artificial classroom environment rather than a grocery sto re). The participants were split into different groups. Those in one group had to sa mple chocolate from a choice of 6 different varieties, while those in anoth er group had to sample chocolate from a choice of 30 differ­ ent varieties. At the end of the experiment, the partici­ pants could either accept $5 in cash or $5 worth of chocolates from the brands they had tasted. Only the choices of those who stated they both enj oyed the choco­ late and had never tried the brand before were analysed. The researchers found that 48 per cent of those in the 6-variety group opted for the $5 box of chocolates instead 1

Sheena S. Iyengar and Mark R. Leppe r, 'When choke is d emotivating: can one desi re too much of a good thing?' , Journal ofPe.rsonoln:yandSocial Psychology, 79•••. 6 (2000). p p . 9 9 51 -006.

of the cash, while the figure for the 30-variety group was only 12 per cent. The results from both the field and labo ratory experiments suggest that people find effective decision making more diffi­ cult when confronted with more choices. In these situations, they often appear to use a simple rule of thumb -do not make a choice at all Survey evidence also suggests that consumers are less satisfied with their choices when faced with numerous options as opposed to just a few. Although the study by Iyengar and Lepper is very famous, results from other research on choice overload are mixed. For example, when Scheibehenne, etal..' repeated the same jam and chocolate experiments, they did not generate the same results. More choice did not hinder the ability of consumers to make effective choices. They also reviewed the data from 50 different experiments and found large differences bet ween the results. On average, the negative impact of choice over­ load was very small. Other research' has found that the chances of choice overload is far greater in particular circumstances. It is more likely when:

■ consumers do no t know very much about the product or ■ ■

service: i.e. they have limited expertise or have not p u r ­ chased it before; the choice has to be made quickly; consumers face a choice of 5 items with 20 different char­ acteristics than a choice of 20 items that each has just a couple of attri butes.

If choice overload does exist, it will be interesting to see if researchers can find more evidence on what makes it more likely to occur and what the i mplications are for businesses.

ofchoice overload. 3 . On what basis wouldyou choose between differentpravid• ers of;nternet., phone and TVservices?

Q.

Devise a survey to establish the basis on which consumers make chokes andwhether more choice encourages people to purchase more.

Benjamin Schei.beht>nne, Rainer Greifen eder and Peter M. Todd, 'C.an there eve r be too many options? A m eta-analytic review ofchoice o verload' ,Joumal of Ct»uumer Research, 37 (October 2010),pp. 4 0 9 25. -

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'AlexanderChernev, Ulf Bodenholt and Joseph Goodman, 'Choice over load: A conceptual review and me ta a- naly sis' JournalofConsumer Psychology, 25, Ho. 2 (2015). pp. 3 3 3 5 - 8.