Before I begin, I’d like to first ask you all to look at the images to the right and note what you see:
Almost everyone immediately perceives the darker circle on the left as being bigger than the one on the right. But is it really? It turns out the two circles are identical, yet just by surrounding that size shape with similar shapes of different sizes, we can immensely impact how the darker circle is perceived. The word perception is important because although the shapes are indeed identical, they are generally perceived to be different. This is this problem with relativity - it is fairly easy to manipulate how one sees something simply by changing the environment around it. Over the next few weeks, we will examine the impact of these theories on our spending. This week: How much is distance worth?
Amos Tversky and Daniel Kahneman explored this idea in their paper “The Framing of Decisions and the Psychology of Choice.” Imagine you are in an office supply store, about to purchase a $25 pen. Aomeone whispers to you that a store 15 minutes away is selling that same pen for $18, a $7 savings. Would you take the drive to save money on the pen? The majority of people would. Next scenario: you are in a clothing store shopping for a $455 coat. Another customer informs you that the same coat is on sale for $448 at a store 15 minutes away. Would you drive the 15 minutes to save the $7 on a $455 coat? The majority of people would not.
One would expect that you would perform a quick cost/benefit analysis, basically: How much you would save minus how much it would cost to drive there (perhaps gas plus cost of time). However, if that were the case, then it wouldn’t matter if the $7 savings was on a $10 item, or a $10,000 item. But clearly that is not the case. Would you make any effort, say even go five minutes down the street to save $7 on a $20,000 car purchase? Not many people would put in that effort. But why? Shouldn’t saving money be worth it regardless of the price of the product you are saving it from?
It turns out that people do not generally base this decision off of a fixed or objective amount, but rather think about it relatively, in terms of a percentage. In the first scenario, the percentage savings were substantial, about 28%. However, in the second scenario, the percentage savings were seemingly insignificant, less than 2%. For some reason, people think about these savings on a relative basis, avoiding such facts such as actual savings in dollars. Nobody balances their checkbook with every withdrawal notated as a percentage of total savings, and products don’t cost a percentage of something - they just have a fixed cost that is deducted from our fixed savings.
Next time you are considering take the drive, or brushing off the worthlessness of taking a drive to save some money, calculate your decision based on actual cost, not percentages. You would be surprised how much money you could save if you think critically about all costs when purchasing something expensive. It’s easy to add options onto a car, leave a negotiation for a house without putting in a full effort or otherwise say something along the lines of “Well I’m already spending so much, what does this extra little bit matter?” If it is worth saving $7 on a pen, it is worth saving $7 on a coat. $7 is $7 no matter how must the product costs.
Over the next few weeks, I hope to bring to light some interesting problems with the way we think about finances in an effort to provide some non-intuitive advise and insight on how to save money in tough economic times. Next week: Spotting the decoy in product marketing.
Further Reading:Almost everyone immediately perceives the darker circle on the left as being bigger than the one on the right. But is it really? It turns out the two circles are identical, yet just by surrounding that size shape with similar shapes of different sizes, we can immensely impact how the darker circle is perceived. The word perception is important because although the shapes are indeed identical, they are generally perceived to be different. This is this problem with relativity - it is fairly easy to manipulate how one sees something simply by changing the environment around it. Over the next few weeks, we will examine the impact of these theories on our spending. This week: How much is distance worth?
Amos Tversky and Daniel Kahneman explored this idea in their paper “The Framing of Decisions and the Psychology of Choice.” Imagine you are in an office supply store, about to purchase a $25 pen. Aomeone whispers to you that a store 15 minutes away is selling that same pen for $18, a $7 savings. Would you take the drive to save money on the pen? The majority of people would. Next scenario: you are in a clothing store shopping for a $455 coat. Another customer informs you that the same coat is on sale for $448 at a store 15 minutes away. Would you drive the 15 minutes to save the $7 on a $455 coat? The majority of people would not.
One would expect that you would perform a quick cost/benefit analysis, basically: How much you would save minus how much it would cost to drive there (perhaps gas plus cost of time). However, if that were the case, then it wouldn’t matter if the $7 savings was on a $10 item, or a $10,000 item. But clearly that is not the case. Would you make any effort, say even go five minutes down the street to save $7 on a $20,000 car purchase? Not many people would put in that effort. But why? Shouldn’t saving money be worth it regardless of the price of the product you are saving it from?
It turns out that people do not generally base this decision off of a fixed or objective amount, but rather think about it relatively, in terms of a percentage. In the first scenario, the percentage savings were substantial, about 28%. However, in the second scenario, the percentage savings were seemingly insignificant, less than 2%. For some reason, people think about these savings on a relative basis, avoiding such facts such as actual savings in dollars. Nobody balances their checkbook with every withdrawal notated as a percentage of total savings, and products don’t cost a percentage of something - they just have a fixed cost that is deducted from our fixed savings.
Next time you are considering take the drive, or brushing off the worthlessness of taking a drive to save some money, calculate your decision based on actual cost, not percentages. You would be surprised how much money you could save if you think critically about all costs when purchasing something expensive. It’s easy to add options onto a car, leave a negotiation for a house without putting in a full effort or otherwise say something along the lines of “Well I’m already spending so much, what does this extra little bit matter?” If it is worth saving $7 on a pen, it is worth saving $7 on a coat. $7 is $7 no matter how must the product costs.
Over the next few weeks, I hope to bring to light some interesting problems with the way we think about finances in an effort to provide some non-intuitive advise and insight on how to save money in tough economic times. Next week: Spotting the decoy in product marketing.
- Predictably Irrational by Dan Ariely
The framing of decisions and the psychology of choice by A Tversky and D Kahneman
Why We Make Mistakes by Joseph T. Hallinan
