Anchoring

You lower your anxiety about uncertainty by producing a number, then you “anchor” on it, like an object to hold on to in the middle of a vacuum.

Ask someone to provide you with the last four digits of his social security number. Then ask him to estimate the number of dentists in Manhattan. You will find that by making him aware of the four-digit number, you elicit an estimate that is correlated with it. 

We use reference points in our heads, say sales projections, and start building beliefs around them because less mental effort is needed to compare an idea to a reference point than to evaluate it in the absolute. We cannot work without a point of reference. 

So the introduction of a reference point in the forecaster’s mind will work wonders. This is no different from a starting point in a bargaining episode: you open with high number (“I want a million for this house” the bidder will answer “only eight-fifty” – the discussion will be determined by that initial level.

Nassim Taleb, The Black Swain

Decoys

We don’t have an internal value meter that tells us how much things are worth. Rather, we focus on the relative advantage of one thing over another, and estimate value accordingly.

High-priced entrees on a menu boosts revenue for a restaurant – even if no one buys them. Why? Because even though people generally won’t buy the most expensive dish on the menu, they will order the second most expensive dish. Thus, by creating an expensive dish, a restaurateur can lure customers into ordering the second most expensive choice (which can be cleverly engineered to deliver to higher profit margin).

Suppose you’re shopping for a house in a new town. Your real estate agent guides you to three houses, all of which interest you. One of them is a contemporary, and two are colonials. All three cost about the same; they are all equally desirable; and the only difference is that on of the colonials the “decoy”) needs a new roof and the owner has knocked a few thousand dollars off the price to cover the additional expense.

So which one do you choice?

The chances are good that you will not choose the contemporary and you will not choose the colonial that needs the new roof, but you will choose the other colonial. Why? Here the rationale (which is actually quite irrational). We like to make decisions based on comparison. In the case of the three houses, we don’t know that much about the contemporary (we don’t have another house to compare it with). So that house goes on the sidelines. But we know that one of the colonials is better than the other one. That is, the colonial with the good roof is better than the one with the bad roof. Therefore, we will reason that it better overall and go for the colonial with the good roof, spurning the contemporary and the colonial that needs a new roof.

Dan Ariely, Predictably Irrational