How Does Anchoring Impact Our Decisions?

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Anchoring is among the most prevalent and impactful cognitive biases that we encounter in our daily lives, particularly when making decisions under uncertainty (Tversky & Kahneman, 1974). By placing too much weight on an initial piece of information — the reference point to which we attach (or “anchor”) or thoughts — the way in which we assess probabilities becomes distorted. As for its prevalence, anchoring is most common when we we deal with new concepts or objects, and most people struggle to overcome its effect, even when given incentives to do so (Simmons et al., 2010) or when they are made conscious of the bias (Wilson et al., 1996).

Anchoring and price

Given how anchoring afflicts us when dealing with new objects, and in situations involving uncertainty, it plays an important role in how we understand and assess prices, particularly of goods with which we are unfamiliar. Beyond pricing, anchoring can actually influence our perceptions of whether a product is good or not — and, in some cases, will dictate whether we consider it fair to pay or to be paid for a certain product or service (Ariely et al., 2006).  This latter example shows just how powerful a simple anchor can be in influencing our perception of a good, and certainly undermines the notion that decision makers are perfectly rational agents.

With respect to our purchases, research suggests that, in forming our opinion of a certain item, we draw from a reference category of similar goods, which serves as our anchor. That is, when evaluating a pair of sneakers, I recall pairs I have purchased (or seen) in the past, and from that decide whether the price is “fair.” Though this behaviour is often quite rational, it demonstrates the way that our previous experiences determine our subjective concept of how goods should be priced — and can be harmful when that anchor does not reflect the underlying value of a good. This concept of initial purchases serving as anchors is known as “coherent arbitrariness” (Ariely et al., 2003).

When anchoring influences our price assessment, it does so by changing the value we ascribe to different objects (Orr and Guthrie, 2005). In that sense, it is a very important tool for price-setting firms, as they determine the range of prices they will place on their products, and how those prices will be perceived by their customers. When a new and original product enters the market, consumers have difficulty valuing the new item without taking some arbitrary past price as a reference point. Thus, firms are able to influence their customers and dictate a reference price for their products. Of course, this is usually done by setting a high anchor price, such that subsequent reductions of the price (discounts, etc.) feel like a bargain and increase consumer demand (Dooley, 2008).

Anchoring can affect experts, too

It is important to note that anchoring is also present in people with a high degree of knowledge and expertise in their respective fields. Such is the case in financial markets, where — despite decades of economists espousing the rationality of markets — asset prices do not seem to be based on underlying value (Summers, 1986) — and, in any case, comparison prices are essential to estimating value of, for instance, the Dow Jones Industrial Index (Shiller, 1998).

As more evidence accumulates as to how — and how often — anchoring affects our construction of value, mainstream economists will need to grapple with how to incorporate this characteristic of human judgment and decision making into models of economic behaviour. Otherwise, our understanding of markets may turn out to be as arbitrary as how we view that pair of sneakers.

References:
Ariely, D. (2008, March 20). The Fallacy of Supply and Demand. The Huffington Post. Retrieved November 2, 2013, from http://www.huffingtonpost.com
Ariely, D., Loewenstein, G., & Prelec, D. (2003). Coherent Arbitrariness: Stable Demand Curves without Stable Preferences. Quarterly Journal of Economics, Vol. 118, No. 1: 73105.
Ariely, D., Loewenstein, G., & Prelec, D. (2006). Tom Sawyer and the Construction of Value. Journal of Economic Behavior and Organization. Vol. 60: 1-10.
Dooley, R. (2008, July 18). Anchor Pricing Strategies. Neuromarketing. Retrieved November 11, 2013, from http://www.neurosciencemarketing.com
Orr, D., & Guthrie, C. (2005). Anchoring, information, expertise, and negotiation: New insights from meta-analysis. Ohio State Journal of Dispute Resolution, 597(21).
Shiller, R. (1998). Human behavior and efficiency of the financial system. Handbook of Macroeconomics.
Simmons, J., Lebœuf, R., Nelson, L. (2010). The effect of accuracy motivation on anchoring and adjustment: Do people adjust from provided anchors? Journal of Personality and Social Psychology, 99(6), 917-932.
Summers, L. (1986). Does the stock market rationally reflect fundamental values? Journal of Finance, 41(3), 591-601.
Tetlock, P., & Mellers, B. (2002). The Great Rationality Debate. Psychological Science 2002, 13: 94.
Tversky, A., & Kahneman, D. (1974). Judgment under uncertainty: Heuristics and biases. Science, 185, 1124–1130.
Wilson, T., Houston, C., Etling, K., & Brekke, N. (1996). A new look at anchoring effects: Basic anchoring and its antecedents. Journal of Experimental Psychology, 125(4), 387-402.

Marco Carrasco Villanueva
About Marco Carrasco Villanueva:

Marco is a Founding Director of the Peruvian NGO Behavioral Economics & Data Science Team (BEST). He graduated summa cum laude with an M.Sc. in Economics and Management from the University of Paris 1: Pantheon - Sorbonne. He currently works at the Ministry of Development and Social Inclusion in Lima, and has held previous roles at the Organization of American States in Washington, DC and the at the Shanghai Academy of Social Sciences in China.