Behavioural economics is a branch of economics that studies the effects of psychological, cognitive, and emotional factors on economic decision-making. It challenges the traditional assumptions of rationality and self-interest in traditional economics and instead focuses on how individuals actually behave in real-world situations. One of the key concepts in behavioural economics is anchoring and adjustment. This concept refers to the tendency of individuals to rely heavily on the first piece of information they receive when making a decision, and then adjust their subsequent judgments based on that initial anchor.
The Role of Anchoring in Decision-Making
In traditional economics, it is assumed that individuals make decisions based on all available information and that they are rational actors who are not influenced by irrelevant factors. However, behavioural economics recognizes that humans are not always rational and can be influenced by various cognitive biases. One such bias is anchoring.When faced with a decision, individuals tend to use the first piece of information they receive as a reference point or anchor. This anchor then influences their subsequent judgments and decisions, even if the anchor is completely irrelevant or arbitrary. For example, imagine you are shopping for a new laptop. The first laptop you see is priced at $2000. Even if this price is higher than what you were expecting to pay, it becomes your anchor for all other laptops you see.
So when you come across a laptop priced at $1500, it may seem like a great deal even though it may still be more expensive than other laptops on the market.
The Adjustment Process
The second part of the anchoring and adjustment process is the adjustment phase. Once an individual has anchored on a particular piece of information, they will then adjust their subsequent judgments based on that anchor. This adjustment is usually not based on rational or logical reasoning, but rather on intuition and emotions. In the laptop example, if the individual's initial anchor was $2000, they may adjust their subsequent judgments by looking for laptops that are slightly cheaper than that price. This adjustment process can lead to individuals making decisions that are not in their best interest, as they are basing their judgments on an arbitrary anchor rather than all available information.Real-World Applications
Anchoring and adjustment have been observed in various real-world scenarios, from pricing strategies used by businesses to negotiations and even in legal settings. In the world of marketing, businesses often use anchoring to influence consumer behavior.For example, a store may advertise a product at a high price and then offer a discount, making the discounted price seem like a great deal even though it may still be higher than the market price. In negotiations, anchoring can be used to gain an advantage. For instance, if a seller sets a high asking price for a house, it can become the anchor for all subsequent offers, making it more likely for the seller to get a higher price. In legal settings, anchoring can also play a role in influencing judgments. For example, when a lawyer presents an initial amount for damages in a personal injury case, it can become the anchor for all subsequent discussions and negotiations.
Overcoming Anchoring Bias
While anchoring and adjustment can lead to irrational decision-making, there are ways to overcome this bias. One approach is to be aware of the potential influence of anchors and actively seek out additional information before making a decision.This can help individuals make more informed and rational choices. Another approach is to use multiple anchors instead of relying on just one. By considering different reference points, individuals can avoid being overly influenced by a single anchor and make more balanced decisions.