I like almost anything by William Poundstone, so I pounced on his latest, Priceless.  It’s about prices.

It’s a bit miscellaneous… Poundstone wants to tell you about psychophysics and pricing consultants and even takes a foray into feminism.  But the overall theme is the irrationality of humans about money, something that’s come as a challenge to some modern overvaluations of The Market.

More precisely, it’s not that humans are irrational; it’s that they’re not rational in the way economists want them to be.

The main myth is that there is such a thing as a single price for an item… even for a single consumer.  It starts with the fact that all our senses and valuations are relative, not absolute.  That is, we have senses of how things compare, but very little good sense of the absolute value of things.

One neat bit: anchoring.  For instance, here’s a number: 56.  Now here’s a question: what’s a fair value for a dinner for two?

You are convinced, of course, that you answered the question without even thinking of the number I named.  Which indeed has nothing to do with dinners for two– I wrote it down before even coming up with the question!  But if we were doing this experiment for real, the results would be that people are influenced by the number; the answer they provide will be skewed in its direction.  It’s an anchor– somehow it affects the next calculation.  It works even if the subjects are told to ignore it.

These days, people happily use anchors in negotiations and in everyday pricing.  One of the simplest techniques is for your store to offer products at three price levels.  People tend to dismiss the lowest level as too cheap, probably shoddy, and the highest as overpriced.  They select the middle one.  But you can set the high and low ends almost arbitrarily.  The very same product, for instance, might be a medium choice at an ordinary supermarket and a low end choice at Whole Foods.

High end stores will have an item on display whose price is absurd.  But it serves as an anchor, making the real high-end items seem like a relative bargain.

Other pricing games show that people are not terribly good at quickly evaluating complex odds.  For instance, which of these offers is better?

  • a 10 in 12 chance of winning $9, otherwise you lose $3
  • a 3 in 12 chance of winning $91, otherwise you lose $21

If you calculated the average payoff, great.  Most people don’t apply the economist’s algorithm, though.  They evaluate whether something seems like a sure thing (and they are none too good at judging rare odds), and they are much more averse to losing what they have than to chances of winning new things.

Then there’s the ultimatum game, which drives economists crazy.  It’s simple: get a bunch of subjects, in pairs.  Each is offered $10.  Person A gets to divide the $10 any way they like, and person B can either accept or reject the division.  If they accept, the money is divided that way.  If they reject it, no one gets any money.

The economist’s reasoning: Person B should accept any offer, including $10 to $0.  After all, even if they’re offered only a pittance, it’s free money.

What actually happens: Most people offer a $6 to $4 split, which is usually accepted.  Person B may or may not accept a $7 to $3 offer.  They almost always reject anything more biased toward person A.

As noted, this experiment just bugs economists, and they’ve repeated it over and over.  (One of the forays into feminism: if person B is a woman, she’ll get slightly lower offers.  This is true even if person A is female.)

I don’t think it’s that shocking, myself.  People hate unfairness, and they don’t like it even within a game.  (The experimenters should probably just join a public gaming server for awhile, if they really think that the artificiality of games, the fact that no money is changing hands, suspends judgments of fairness.)  As social animals, we need to be extremely conscious of unfairness.  We didn’t evolve to be homo economicus, and if we had, we probably wouldn’t have developed an elaborate civilization.

Curiously, results from the ultimatum game differ across cultures.  Wherever there are markets and cooperative projects– which is to say, in most cultures– selfishness is punished.  Among the Machiguenga, who have neither, offers were consistently lowballed, and accepted.  The Ache hunter-gatherers, whose hunting superstars generously share their catches, would offer person B more than half.  So did the Au, of Papua New Guinea, but in that case, person B would reject the deal.  Among the Au, generous offers impose a debt, and people don’t always want to take on that obligation.

Anyway, fun book, lots more stuff like this.  As mentioned, though, it covers a lot of ground and not all of it may stick with you.