You are going to read an article about economics. For each question, choose the answer which you think fits best according to the text.
Consumers are suckers for “special” deals that are costlier than they first appear
The lyrics of “Step Right Up”, a 1976 recording by Tom Waits, a gravel-voiced American singer, are a lexicon for hawkers and street traders. In the course of the song’s six minutes, the singer-pedlar makes ever-bolder claims for his wares. A wise consumer might not shell out for the wonder-product that “mows your lawn” and “picks up the kids from school” as easily as it “entertains visiting relatives” and “gets rid of your gambling debts”. But he might still be tempted by a “year-end clearance” that promised “50% off original retail price”.
A new study* for the Office of Fair Trading, Britain’s main competition-policy watchdog, seems to confirm that the way prices are presented, or “framed”, can tempt consumers into error. Its authors, Steffen Huck and Brian Wallace of University College London (UCL), and Charlotte Duke of London Economics, a consultancy, base that finding on a controlled experiment. They tested responses to five different price frames: “drip pricing”, where only part of the price is revealed at first and extra charges are levied as the sale progresses (think of buying an airline ticket online); “sales”, where the price is contrasted with a higher price (was $2, now $1); “complex pricing”, such as three-for-two offers, where the unit price has to be worked out; “baiting”, where a cheap deal is advertised but restricted to a few lucky shoppers; and “time-limited offers” that are available for a short period.
The experiment’s subjects were 166 UCL students who played at being shoppers in a computer game. Shoppers were faced with a choice between two stores selling an identical good and were given a score for each purchase. The greater the difference between the rewards for owning the good and the prices they paid, the wiser their purchases, and the higher the score, or “pay-off”. Since consumers obtain less satisfaction from buying more of the same stuff, the rewards dropped for each extra purchase they made, from 120 points for the first unit to 80 for the second and so on up to a maximum of four purchases per round. A “search cost” was also levied each time a shopper visited a shop to ask about prices. The prices in each shop (and for each frame) were selected at random from between 60 and 120. All prices in that range were equally likely. Each subject played ten rounds of a “baseline” game where goods were sold at “straight” per-unit prices, and a further ten rounds each for two of the five price frames.
The authors worked out the best way to play the game so they could judge just how befuddled consumers were by each kind of price frame. This optimal strategy is quite complex and varies with the frame and the search costs. A simple rule of thumb is that a price offer below 80 in the first shop should be snapped up straight away. The expected price in the second shop is 90 (halfway between 60 and 120) so the chance that a lower price would be offered is fairly slim. At a price above 80, however, it usually makes sense to seek a better offer. When the price in both shops is above 80, the wise shopper buys only one unit.
How did shoppers fare? Faced with per-unit prices, shoppers made the right choices four times out of five. But when errors were made they were costly. The average lost pay-off per round compared with the best strategy was enough to cut the maximum score by a quarter. The errors were still larger in the rounds where prices were framed differently. The authors calculated the additional loss each subject suffered in response to each price frame compared with the baseline case. The average extra loss was then used to rank the five price frames. Shoppers were worst off under drip pricing, followed by time-limited offers, baiting, sales and complex pricing.
Shoppers made two sorts of mistakes. Less than 10% were purchasing errors—buying too little when the price was right or too much at steep prices. The most frequent mistake was to shop around too much or too little. Under straight per-unit pricing, consumers tended to over-search. This pattern was reversed for the price frames: shoppers tended to snatch at the deals offered in the first shop. In the drip-pricing frame, for instance, more than a quarter of consumers bought at the first shop when it would have been wise to continue the search.
The deeper causes of these errors vary. In the drip-pricing and baiting frames it seems that shoppers, having resolved to buy a good, feel as if they already own it. To abandon the sale would feel like a loss. With sales and time-limited offers, shoppers believe they will miss out if they do not buy at once, even though prices are unlikely to be any keener than in the other shop.
The Price is Wrong
Although consumers clearly lost out there were no corresponding overall gains for retailers. Sales volumes were virtually the same whichever way prices were presented. The main effect was on the distribution of sales. The first shop to lure shoppers sold many more goods, as consumers grabbed at poor deals. That made some firms better off but others (which would have offered better deals) were worse off. Most price frames made for lousy matches between shoppers and retailers, a bad result all around.
There might seem to be a case for judicious intervention since both sellers and buyers suffer. But regulators need to be careful. Firms may offer special deals for valid reasons such as boosting sales volumes. Many want to avoid the reputational risk that goes with sharp practice. What’s more, shoppers in this experiment made the right decisions most of the time, even when faced with drip pricing. And the study shows that consumers learn lessons: they made better decisions as the experiment progressed. The best remedy, it seems, is for consumers to be better informed and wary about special deals. “You got it, Buddy,” sang Mr Waits: “The large print giveth and the small print taketh away.”
*“The Impact of Price Frames on Consumer Decision Making”. Office of Fair Trading, May 2010.
(adapted from The Economist)