Heuristics, Biases, and the

Context of Judgments
Dr. Kelly Haws

Key Questions
What are some known ways in which our
decision making is biased?
How can an understanding of these biases aids
marketers/consumers?
What is good decision making?
How does prospect theory affect our judgments?
How can simple aspects of a retail or decision
environment have a dramatic impact on our
consumption decisions?

Readings
Nudge, Chapter 1, Biases and Blunders, pp. 1539. (Course pack pp. 110-121) TEAM
Why Smart People Make Big Money Mistakes,
Chapters 2 & 5, When Six of One Isnt Half a
Dozen of the Other, and Anchors Aweigh, pp.
51-59 and 129-135. (Course pack pp. 122-130)
Paradox of Choice, Chapter 4, When Only the
Best Will Do, pp. 77-96. (Book)
Why We Buy, Chapters 3 and 4, The Twilight
Zone and You Need Hands, pp. 45-59. (Book)

Behavioral
Economics &
Consumer DecisionMaking

Our decision-making processes might

not be as perfect as we think

Lets take a
closer look.

Do we experience decision illusions in

the same way we experience optical
illusions?

If we make persistent errors in things

we are very good at like numbers,
letters, colors, and shapes
how likely is it that we are also
subject to persistent, predictable
errors in areas of consumer
decision-making?

Heuristics and Biases

Heuristics are decision making shortcuts that
help us make quick and easy decisions
Biases occurs when these quick and easy
decisions are not optimal.

Context of Judgments:
Prospect Theory
(Kahneman & Tversky 1979)
People dont follow a traditionally rational theory
of choice
It applications include:

Framing
Loss Aversion
The Endowment Effect
Reference points

Prospect Theory
(Kahneman & Tversky 1979)
We will begin looking at this theory today, and then
continue over the next couple of weeks.
XX

But first, the basics

Amount of pleasure
you get from
WINNING $1000

Amount of pain you feel

from LOSING $1000

Adding to an existing
loss puts you at the
bottom of the curve
you experience only a
small increase in pain.

Loss aversion and framing

If the same choice is
framed as a loss,
rather than as a
gain, different
decisions will
be made.

 When an investor
sells a losing stock,
she is committing to
the loss.
Does loss aversion
cause investors to
hold losing stocks
longer than winning
stocks?

THE CONTEXT OF JUDGMENTS

Although students were reminded that

the social security number is a random
quantity conveying no information,
those who happened to have high
social security numbers were willing
to pay much more for the products.
Ariely, D. (MIT), Lowenstein, G. (Carnegie Mellon), & Prelec, D. (MIT), 2006, Tom Sawyer and the construction
of value. Journal of Economic Behavior & Organization, 1-10.

Experiment:
Business students were told their
professor would be doing a 15minute poetry reading. Half were
asked if they would be willing to
pay $2 to attend and half were
asked if they would be willing to
attend if they were paid $2. After
answering, students were then told
that the poetry reading would be
free and were asked if they wanted
to attend.
Question:
Would the initial anchoring of the
experiences value affect who
would attend for free?
Ariely, D. (MIT), Lowenstein, G. (Carnegie Mellon), & Prelec, D. (MIT), 2006, Tom Sawyer and the construction
of value. Journal of Economic Behavior & Organization, 1-10.

Perhaps
students
were just
using price
as an
estimate of
unknown
quality?

Experiment #2:
Now the professor first read
poetry for 1 minute so that
students actually experienced it.
Then one group was asked if
they would be willing to pay to
attend, the other group if they
would be willing to attend if
paid.
Question:

Would the anchoring effect go

away when people were
allowed to sample the
experience first?
Ariely, D. (MIT), Lowenstein, G. (Carnegie Mellon), & Prelec, D. (MIT), 2006, Tom Sawyer and the construction
of value. Journal of Economic Behavior & Organization, 1-10.

When bread makers were new

Williams-Sonoma, a mail-order and
retail business located in San
Francisco, used to offer one home
bread maker priced at $275. Later, a
second home bread maker was
added, which had similar features
except for its larger size. The new
item was priced more than 50%
higher than the original bread maker.
Williams-Sonoma did not sell many
units of the new (relatively
overpriced) item, but the sales of the
less expensive bread maker almost
doubled.

Simonson, I. (Stanford), 1999, The effect of

product assortment on buyer preferences,
Journal of Retailing, 75(3), 347-370.

Producers want to
anchor to a higher
priced alternative
Even if it means creating
an artificial alternative

Producers avoid
anchoring to a lower
priced alternative
Differentiation is key
If we anchored Starbucks coffee
by Dunkin Donuts coffee, would
we buy Starbucks?

MARKETING
Implications of Prospect Theory:
Segregate gains

Car descriptions list out attributes separately

Integrate losses

Car dealers list price in one lump sum

Why we hate phone bills, itemized tuition bills, Ticketmaster
Why we like all inclusive vacations

Silver lining effect

Separate out small gain from big loss

$500 cash back when you buy a Nissan

Gifts with purchase

Cancel losses against larger gains

Paycheck deductions for insurance or investments