Rational Consumers. Irrational Decisions.

Image Credits- La iguana TV

Consumers are overwhelmed with an inordinate amount of information while making product choices today. From product choices to service offerings, decision-making is becoming increasingly complex. Despite the incessant access to vast information and seemingly rational tools for making decisions, consumers frequently make choices that appear irrational. Cognitive biases, which are systematic patterns of deviation from rationality in judgement, are the major drivers of such irrationality in decisions. These biases, including anchoring, framing, and loss aversion, often subconsciously lead consumers to make suboptimal choices. Understanding these biases is essential for consumers, businesses, and policymakers alike as they significantly influence purchasing behaviours, marketing strategies, and even broader economic outcomes.

What Are Cognitive Biases?

Cognitive biases are systematic errors in the way individuals reason about the world due to subjective perception of reality. Although cognitive biases can lead to irrational decisions, they often stem from mental short-cuts, such as heuristics. Heuristics is short-cutting information with the mentality of thinking "it's close enough". Heuristics can be useful in some contexts, however, it sometimes lands one within the pitfalls of judgement errors. Psychologists Amos Tversky and Daniel Kahneman, who are considered to be the pioneers of behavioural economics, demonstrated in 1974 that human beings often use cognitive shortcuts to make decisions. These biases do not occur only in isolated or specific events but also are part of everyday consumer behaviour.  This influences how consumers assess products, compare prices, interpret advertisements, and determine whether or not to make a purchase. Three common types of bias that influence consumer choice are anchoring, framing, and loss aversion. Understanding of these particular types of biases is imperative to ascertain their overall impact on consumer decision making.

Anchoring: The Power of First Impressions

It is another form of cognitive bias wherein a person relies too heavily on the first piece of information available to him (the "anchor") when making a decision. Subsequent decisions after an anchor is laid are readjusted in anchoring around it, although the anchor might itself be misleading. The theory of anchoring bias is very important in the context of consumer behaviour, pricing, and negotiation. For example, when a consumer views an article and it is marked "50 percent off," the consumer will probably consider the sum he pays as being an excellent bargain, even though the list price was an inflated number.

The anchor is the original price, and then there is the perceived discount to zero in on; thus the consumer is probably not concerned with the actual value of the item. This phenomenon is exploited in retail settings, where businesses frequently use high "anchor" prices to make discounts seem more attractive. In consumer behaviour, anchoring works similarly—whether it's a price, product rating, or brand name, the first piece of information consumers encounter tends to disproportionately shape their final decision. 

In order to understand this better, let us consider the case of online shopping. Consumers often start with the most expensive items in a category when shopping online for products. Although they do not plan to purchase some of the luxury products, their high prices serve as anchors. As the consumer later encounters midrange or lower-priced products, those seem like much better values than the expensive products introduced previously, forcing irrational purchases based on the difference between the options offered.

Framing: When Context Matters

Another cognitive bias that has been known to affect purchasing behaviour of consumers is Framing. It refers to the way in which information is presented and how that presentation influences decision-making. Consumers perceive and tend to react differently to the same information depending on how it is framed. In 1981, Kahneman and Tversky conducted a study on decision-making under risk and found that people are more likely to choose an option when it is framed in terms of potential gains rather than potential losses. That is to say, participants were more likely to choose a medical treatment when told it had a "90% survival rate" than when told it had a "10% mortality rate," even though both statistically convey the same information. In the realm of consumer behaviour, framing poses a powerful tool for marketers. We can better understand this with the example of supermarkets. Suppose there are two products – one of them is labelled as “90% lean” while the other is labelled as “10% fat”. Notice how each of them convey exactly the same information but differ in their framing which changes the context in which they are perceived by consumers. The consumers would more likely take the "90% lean" simply because the positive framing evokes the impression of healthy while the "10% fat" label will viscerally draw attention to the negativity. This bias influences consumers to make irrational choices while buying products. Keeping in mind the context of the information, consumers prefer products based on the fact of how information is presented rather than on the actual attributes of the product itself. 

Marketers use framing in a variety of ways, from descriptions of products to advertisements for products. "Buy one, get one free" offers are framed in a positive light by focusing on the value received to attain a benefit, even though an equivalent price decrease would accrue the same savings to the consumer. In this case, how the promotion is framed makes the value even more tempting, and may even lure consumers to purchase products they wouldn't have considered otherwise.

Image Credits- Despark

Loss Aversion: The Fear of Losing Out

Loss aversion, another fundamental cognitive bias, describes the human tendency to prefer avoiding losses rather than acquiring equivalent gains. In other words, losing $100 feels more painful than the pleasure derived from gaining $100. This aversion to loss can heavily influence consumer decisions and is frequently exploited in marketing. One of the more obvious uses of loss aversion in a consumer's behaviour is the "fear of missing out" (FOMO) that retailers bring by offering limited-time sales or "flash sales". Businesses frame the purchase as an opportunity that will soon disappear and strike consumers' loss aversion for the fear of missing a deal. Even if the consumer wasn't interested in buying the product, the mere fact that it won't be there in the future can activate an irrational purchase. For instance, online retailers including Amazon, and e-commerce sites use countdown timers very often on products, encouraging consumers to buy the stuff in time because, after all, an offer can disappear anytime. That is where creating urgency and the feeling of loss aversion comes into play, exposing consumers to acting in the belief that a good deal is going to slip away-in much the same way as those "only 2 left in stock!" messages.

A study by Kahneman and Tversky (1979) demonstrated that losses have a greater psychological impact than equivalent gains. Loss aversion can cause consumers to hold onto subscriptions or services they no longer need simply because the idea of cancelling feels like a loss, even when it would be financially beneficial to stop paying for them.

The Intersection of Biases in Consumer Choice

These cognitive biases do not operate in isolation. Often, multiple biases work together, leading to even more irrational decisions. For example, loss aversion may be amplified when combined with anchoring. If a consumer believes they are getting a product at a significant discount (thanks to an anchored original price), the fear of losing that "deal" may make them more likely to buy the item, even if they don’t need it or it doesn’t fit their budget. Additionally, framing effects can exacerbate the power of loss aversion. For instance, an advertisement might emphasise how many people have already taken advantage of a deal, creating a sense of social proof and urgency. When combined with a countdown timer or a limited-time offer, consumers may feel an overwhelming pressure to make a purchase.

The understanding of cognitive biases is imperative to both consumer and the marketer. For consumers, awareness of types of cognitive biases prevents them from doing irrational things. Simple strategies to eliminate or reduce the effects of biases like anchoring and framing can be learned by taking time for reflection over purchases, comparing alternatives, or determining whether the product is actually needed. To marketers, these biases offer opportunities to craft better advertisement and sales strategies. By anchoring prices optimally, while framing information in ways that highlight benefits and using loss aversion with time-limited offers, marketers increase the chances of succeeding in changing buyer behaviour in their favour. Once again, there is an ethical slant here. Those strategies could work but the companies should not compromise business ethics to take advantage of the cognitive biases to manipulate people into making harmful choices. Choices which will push the consumers towards impulsive buying of items which they would not ordinarily, because of the items being unnecessary or over-expensive.

Conclusively, cognitive biases such as anchoring, framing, and loss aversion play a significant role in shaping consumer behaviour, however they often lead to irrational choices. While these biases can serve as useful tricks or shortcuts in certain situations, they also make the consumers vulnerable to unfair exploitation in the marketplace. By understanding the underlying psychological mechanisms at work, both consumers and marketers can navigate through the complex world of decision-making more tactfully and effectively. For consumers, awareness of these biases is a step toward making more informed, rational decisions, while for marketers, these biases provide powerful tools for influencing purchasing behaviour.

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By-

Kashvi Ratna

I am a grade 12 student at Seth M.R. Jaipuria School, Lucknow, with a deep sense of interest in economics and research. An avid reader and researcher, I write articles that delve into the intricacies of economic theories, policies and innovation, with many being published in the school newspaper. Through my creative expression, I aspire to contribute meaningfully to the field of economics.

Chinmay Jain

I am a class 12 student with a profound sense of passion for economics studying at the Seth M.R. Jaipuria School, Lucknow. I enjoy exploring and writing about various economic theories, aiming to make complex ideas accessible to a wider audience. My work has been featured in the Economics Society of Sri Ram College of Commerce, Delhi, and I have also contributed a research paper on risk aversion and fear of failure to the International Journal of Science and Research (IJSR).

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References 

Tversky, A., & Kahneman, D. (1974). Judgment under Uncertainty: Heuristics and Biases. Science, 185(4157), 1124–1131. https://doi.org/10.1126/science.185.4157.1124

Kahneman, D., & Tversky, A. (1979). Prospect Theory: An Analysis of Decision under Risk. Econometrica, 47(2), 263. https://doi.org/10.2307/1914185

Tversky, A., & Kahneman, D. (1981). The framing of decisions and the psychology of choice. Science, 211(4481), 453–458. https://doi.org/10.1126/science.74556