How Can You Tell Whether an Item's Price Is a Good Price?
Prices can be difficult to make sense of compared with other product features.
Posted May 6, 2019
Imagine this scenario. You are out shopping at a farmer’s market on a beautiful spring weekend.
As you walk past a stand devoted to healthful ancient grains, you see an eye-catching one-pound package of locally-grown organic amaranth. The package looks expensive. It's made of hand-sewn sackcloth, like something you’d find in a Victorian market. Its price tag says $8.79. Is this a good price?
And more importantly, assuming you're interested in purchasing it, how much weight will you give the price in your buying decision compared to the packaging, the fact that the amaranth is locally sourced and sustainable, or some other aspect?
Surprisingly, the answer depends on how easy or difficult the stand-owner makes it for you to assess the amaranth’s price, not just your own price knowledge. To understand why this is the case, consider the following question asked to undergraduate students in an academic study:
“Imagine that you are a music major and are looking for a specialized music dictionary in a used-book store to use for your studies. Let’s say you have planned to spend between $10 and $50 for your purchase. You come across a dictionary which looks brand new, and it has 10,000 entries in it. How much would you be willing to pay for it?”
On average, study participants said they would be willing to pay $24 for this dictionary. Another group from this same undergraduate pool was given a somewhat different scenario. The dictionary they saw had a torn cover but was otherwise in good shape. It had 20,000 musical entries. Participants were willing to pay an average $20 for this dictionary. The author referred to these conditions as “separate evaluation” study conditions because participants only saw a single dictionary and then considered how much they'd be willing to pay.
Interestingly, there was also a third group in the study. Unlike the first two groups, these people saw both music dictionaries side-by-side. What do you think they were willing to pay in this “joint evaluation” task? Not surprisingly, they were willing to pay more for the torn music dictionary with 20k entries ($27) than the brand new dictionary with 10k entries ($19).
Behavioral economists call this phenomenon a “preference reversal” because the relative valuations of the two dictionaries reversed depending on whether the individuals evaluated them separately or side-by-side. When evaluating separately, people were willing to pay more for the dictionary with fewer entries but in pristine condition. But when evaluated together, they valued the one with more entries even though it was torn.
Why did this reversal happen?
The answer lies in the fact that as consumers, we find some product attributes easy to use in our decision making by themselves but have difficulty with others. For instance, it’s easy to say that a torn dictionary is bad or that a brand new one is good in and of itself. The number of entries in a music dictionary, not so much. How is one to know how many entries is a good number for a music dictionary?
What’s more, people tend to use attributes that are easy to use and make sense of in their decision making. This is why, when considered separately, potential buyers were willing to pay more for the brand new music dictionary than the dictionary with the torn cover even though it had twice as many music entries. They were not able to make sense of the number of entries in standalone decisions, so they ignored it.
This problem disappeared when the two dictionaries were compared side-by-side. Here, people could easily discern the significance of the number of entries because they had two values to compare. The relative superficiality of the dictionary’s appearance combined with the greater importance of the number of entries in the dictionary were both easily evident. Accordingly, buyers were now willing to pay significantly more money for the dictionary with 20k entries and the torn cover.
What does this study have to do with evaluating prices?
Most of us have poor knowledge of product prices, especially for products we don’t buy regularly. Relative to its other features, a product’s price typically tends to be more difficult to make sense of. Returning to the $8.79 amaranth package, if you're like me, you won't be able to make heads or tails of whether this is a reasonable price. A savvy seller could highlight amaranth’s nutritional properties, or provide a detailed explanation about how it was grown, explaining its farm-to-table credentials. These features would all be relatively easy to judge and use on their own for shoppers. Just like the brand new condition of the music dictionary, emphasizing these features would drive up customers’ willingness to pay, making the $8.79 price appear to be ok.
On the other hand, what if, for some reason the farm-stand owner wanted the shopper to pay more attention to price instead of other features? They would need to provide the shopper with some assistance. For instance, placing a sign saying something like, “Amaranth of this quality typically costs $8-$15 per pound,” would imply that the $8.79 price is on the low side. Alternatively, tagging a regular higher price, say $11.99, and indicating that the “today only” sale price is $8.79 would work. Providing some direct guidance about prices to help the shopper would make it much easier to use price and increase its influence in the buying decision.