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Scenario A: Imagine you’re at a store looking to buy a new barbecue
grill. You find a Weber Q 320 grill that looks pretty good, and to your
delight it’s also on sale. Originally priced at $350, it is now marked
down to $250.
Would  you  buy  this  barbecue  grill  or  drive  to  another  store  to  look  at
others? Take a second to think about your answer. Got it? Okay, let’s do the
exercise again for a different retailer.
Scenario B: Imagine you’re at a store looking to buy a new barbecue
grill. You find a Weber Q 320 grill that looks pretty good and to your
delight it’s also on sale. Originally priced at $255, it is now marked
down to $240.

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What  would  you  do  in  this  case?  Would  you  buy  this  barbecue  grill  or
drive to another store to look at others? Wait until you have an answer and
then read on.
If you’re like most people, scenario A looked pretty good. One hundred
dollars  off  a  barbecue  grill  and  it’s  a  model  you  like?  Seems  like  a  good
deal. You probably said you’d buy it rather than keep looking.
Scenario  B,  however,  probably  didn’t  look  so  good.  After  all,  it’s  only
fifteen dollars off, nowhere near as good as the first deal. You probably said
you’d keep looking rather than buy that one.
I found similar results when I gave each scenario to one hundred different
people. While 75 percent of the people who received scenario A said they’d
buy  the  grill  rather  than  keep  looking,  only  22  percent  of  people  who
received scenario B said they’d buy the grill.
This all makes perfect sense—until you think about the final price at each
store. Both stores were selling the same grill. So if anything, people should
have been more likely to say they would buy it at the store where the price
was  lower  (scenario  B).  But  they  weren’t.  In  fact,  the  opposite  happened.
More people said they would purchase the grill in scenario A, even though
they would have had to pay a higher price ($250 rather than $240) to get it.
What gives?
THE PSYCHOLOGY OF DEALS
On a cold, wintry day in December 2002, Daniel Kahneman walked onstage
to  address  a  packed  lecture  hall  at  Sweden’s  Stockholm  University.  The
audience  was  filled  with  Swedish  diplomats,  dignitaries,  and  some  of  the
world’s most prominent academics. Kahneman was there to give a talk on
bounded rationality, a new perspective on intuitive judgment and choice. He
had  given  related  talks  over  the  years,  but  this  one  was  slightly  different.
Kahneman was in Stockholm to accept the Nobel Prize in Economics.
The  Nobel  Prize  is  one  of  the  world’s  most  prestigious  awards  and  is
given to researchers who have contributed great insight to their disciplines.
Albert Einstein received a Nobel Prize for his work on theoretical physics.
Watson  and  Crick  received  a  Nobel  in  medicine  for  their  work  on  the
structure  of  DNA.  In  economics,  the  Nobel  Prize  is  awarded  to  a  person
whose research has had a large impact on advancing economic thinking.
But Kahneman isn’t an economist. He is a psychologist.

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Kahneman received the Nobel for his work with Amos Tversky on what
they called “prospect theory.” The theory is amazingly rich, but at its core,
it’s  based  on  a  very  basic  idea.  The  way  people  actually  make  decisions
often violates standard economic assumptions about how they should make
decisions.  Judgments  and  decisions  are  not  always  rational  or  optimal.
Instead, they are based on psychological principles of how people perceive
and process information. Just as perceptual processes influence whether we
see a particular sweater as red or view an object on the horizon as far away,
they also influence whether a price seems high or a deal seems good. Along
with Richard Thaler’s work, Kahneman and Tversky’s research is some of
the earliest studying what we now think of as “behavioral economics.”
—————
One  of  the  main  tenets  of  prospect  theory  is  that  people  don’t  evaluate
things  in  absolute  terms.  They  evaluate  them  relative  to  a  comparison
standard, or “reference point.” Fifty cents for coffee isn’t just fifty cents for
coffee.  Whether  that  seems  like  a  fair  price  or  not  depends  on  your
expectations. If you live in New York City, paying fifty cents for a cup of
coffee seems pretty cheap. You’d chuckle at your good luck and buy coffee
from that place every day. You might even tell your friends.
If  you  live  in  rural  India,  though,  fifty  cents  might  seem  hugely
expensive.  It  would  be  way  more  than  you  would  dream  of  paying  for
coffee and you’d never buy it. If you told your friends anything it would be
your outrage at the price gouging.
You  see  the  same  phenomenon  at  work  if  you  go  to  the  movies  or  the
store with people in their seventies or eighties. They often complain about
the prices. “What?” they exclaim. “No way am I paying eleven dollars for a
movie ticket. That’s such a rip-off!”
It might seem that old people are stingier than the rest of us. But there is
a more fundamental reason that they think the prices are unfair. They have
different  reference  points.  They  remember  the  days  when  a  movie  ticket
was  forty  cents  and  steak  was  ninety-five  cents  a  pound,  when  toothpaste
was  twenty-nine  cents  and  paper  towels  cost  a  dime.  Because  of  that,  it’s
hard for them to see today’s prices as fair. The prices seem so much higher
than what they remember, so they balk at paying them.
Reference points help explain the barbecue grill scenarios we discussed a
few  pages  ago.  People  use  the  price  they  expect  to  pay  for  something  as

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their  reference  point.  So  the  grill  seemed  like  a  better  deal  when  it  was
marked down from $350 to $250 rather than when it was discounted from
$255 to $240, even though it was the same grill. Setting a higher reference
point  made  the  first  deal  seem  better  even  though  the  price  was  higher
overall.
Infomercials often use the same approach.