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Decision Biases and Constructed Preferences

So let’s consider some implications of the idea of constructed preferences. I’ll introduce two decision biases: the first is called the decoy effect and the second, the compromise effect.

The decoy effect

Suppose that you are in the market for a wine refrigerator. I don’t mean a fancy wine storage closet with multiple cooling zones and custom racking, I mean a simple refrigerator dedicated to holding bottles of wine. I picked this because it’s a relatively simple product, one that basically varies on two key features: size and price.

Let’s also suppose that each of these features matters for your decision: larger is better than smaller and less expensive is better than more expensive. You walk into an appliance store and you see two models on display: model A only holds 24 bottles of wine and costs $100, while model B holds 36 bottles of wine the cost $150. So your choice is between a smaller cheaper model A in a larger more expensive model B. How do you make that decision?

What you should do seems clear you should look at each model, determine its value and choose the one with the greatest value relative to its price. Your choice should be determined only by your intrinsic preferences and by information about model A and model B, but we don’t always do appreciate. While you’re thinking about your options you suddenly notice the third model C; it holds 30 bottles of wine and cost $175, it’s objectively worse than model B and that is smaller and more expensive.

So it should be irrelevant your decision between models A and B but it’s not. Model C in this example is what behavioral economists call a decoy, it is objectively worse than one of the other options and a choice set so it shouldn’t be chosen itself, but decoys shape the process of choice. Suddenly the large but expensive model base seems like a really good deal 36 bottles for $150 that’s much better than 30 bottles for $175.

So the introduction of the irrelevant decoy the new model C which you would never choose eliminate your indecision. You choose B the option clearly better than the decoy and you walk out of the store confident in your purchase. In summary the decoy effect arises when the introduction of an unchosen option shifts what we value, specifically biasing us toward an option that seems objectively better than the decoy.

Marketers often use decoy effects if not always as part of a conscious plan and some political scientists have argued that decoy effects can influence elections. For example, the introduction of a third party candidate can shift undecided voters toward one of the two major party candidates.

The compromise effect

Now move to a second decision bias: the compromise effect. Let’s suppose that you are planning an extended stay in an expensive city say London you are searching for an apartment to rent for the duration of your visit but suitable apartments are scarce and you only have three options: option one is an ideal location right in the city center but it is very expensive, close to the limit of your budget; option two is a few tube stops out from the heart of the city and is moderately priced and option three is at the very end of a tube alignment in the suburbs, but is also very inexpensive.  Which do you choose?

You’ve probably been in a situation that that has this basic flavor, here there are no objectively better or worse options. The different options progressively trade off location and cost, what people tend to do in such situations is compromise, they tend to pick the intermediate choice the one that isn’t the closest nor the farthest not the cheapest nor the most expensive, they pick the option that seems like a compromise between the extremes. Compromise is not always in our interest when we compromise we don’t get to take advantage of the extremes.

It might actually be a good idea to pick the best located hotel room, the cheapest bottle of wine or the most reliable car and if we consistently compromise, we can be exploited: a restaurant owner can make an expensive bottle of wine’s pricing more reasonable by adding a rare and even more expensive bottles of the wine list as it happens with range effects. Constructed preferences lead to biases like: preference reversals decoy effects and compromise effects.

So why do we construct value if it leads to so many mistakes? why aren’t our preferences more consistent and more stable so that we can look them up when needed? There are two answers to these questions. The first answer is that these biases actually help us make decisions. Think about the sorts of scenarios I described in this lecture: you are faced with a difficult choice between two or more similar items. Those items have different advantages and disadvantages, but it is often hard to know what’s really important.

So if there is an option that you won’t regret either because it is clearly better than some other option or because it is a good compromise you can choose it and get on with the rest of your life. None of these biases overrides all other factors and motivate your decision, instead they tend to push you one way or the other when you’re faced with a particularly difficult choice. The second answer is a bit more complicated our preferences are constructed because that’s how our brains have to work.

We don’t always know what factors are going to be relevant to a decision, in part because we have to value such dissimilar things. We weigh time versus effort, we trade money for food.