One Reason We Think a High Price Looks Low

The decisions we make about bread machines, surgery and gasoline can be remarkably similar.

Where are we going? To the influence of a frame.

But first…

Bread Machines

Maybe 20 years ago, when bread machines were first introduced, one retailer started with a single model priced at $120. Faced with sparse sales, they increased interest by adding a second $80 machine.

What happens next though is what gets the behavioral economists really excited. The retailer placed a $475 machine on the shelf and the $120 model sold like hotcakes.

Surgery

In an experiment at Harvard by psychologist Amos Tversky, physicians were given one of two statements about the success of a surgical procedure. Asked if they should operate, the majority of respondents said yes to the first statement. Both though are the same:

• The one-month survival rate is 90 percent.
• There is a 10 percent mortality in the first month.

and finally…

Gasoline

Asked if $3.00 a gallon gas makes you happy, you probably would say no. But why then, a year ago, would you have been pleased?  The following graph has the clue:

Frames

For bread machines, surgery and gasoline, our attitudes are shaped by a reference point that behavioral economists call a frame. With the bread machines, the $425 machine signaled that $120 was a good price. For surgery, when the frame was a positive statement, the response was positive. For gasoline, the direction in which prices moved created the frame. Moving downward from $4.00, $3.00 looks good but not when price rises from $2.00.

Our Bottom Line: Competition

In traditional economic texts, price making power increases as you move across the following continuum:

To enhance their price making power, firms have been able to influence consumers with frames. Now though, with Amazon and the potential for other online price comparisons, I wonder if the power to frame has diminished or at least changed.