"By using these psychological factors as competitive tools, firms may be able to raise demand without suffering from adverse selection, all the while dulling the incentives for price competition."
Classical models of consumer choice presume individual rationality: that is, that consumers make important decisions by weighing costs, benefits, and preferences. Psychology, in contrast, emphasizes the importance of context and cognitive limitations. Preferences are considered to be malleable, and limited rationality makes problem solving conflicted and error-prone. A growing body of evidence from laboratory psychology experiments supports this view of consumer choice. It suggests that choices can be manipulated by framing the context, visual cues, and other factors that change the presentation of the choice but not its content or inherent value.
Economists are often skeptical about the external validity of findings from laboratory experiments. In What's Psychology Worth? A Field Experiment in the Consumer Credit Market (NBER Working Paper No. 11892), authors Marianne Bertrand, Dean Karlan, Sendhil Mullainathan, Eldar Shafir, and Jonathan Zinman design a set of marketing treatments for consumer banking in order to mimic the "cues" and "frames" that have been shown to influence consumer choice in the laboratory. With the cooperation of a bank in South Africa, they devise a field experiment to test various psychological factors that might influence borrowing behavior. For example, they vary whether the lender's rate was compared to a competitor's (thereby establishing a reference level), and whether this comparison was presented as a loss or a gain. They also experiment with suggested loan uses and with the addition of photographs to the loan offer letter, because psychology has found that visual cues can be used to arouse emotions that are conducive to consumption. None of the marketing treatments changed the economic terms of the loan offer; they only varied the fashion in which the loan offer was presented. Consumers in this study were experienced borrowers, with the median client securing three prior loans from the lender.
The authors find that a firm can exploit consumers' psychological biases, thereby increasing demand without lowering prices. The authors stress three key features of their findings. First, while several of the psychological manipulations they attempted affected demand, several did not, suggesting that psychological effects are very context-sensitive and may require experimentation to pin down. To a degree, this is not unlike the experimentation that firms engage in to pin down the "optimal price" for a product or service.
Second, the magnitude of these psychological effects is large, with each statistically significant intervention equivalent to drops in the monthly interest rate ranging from one percentage point (most often) to sometimes as much as four percentage points.
Finally, by using these psychological factors as competitive tools, firms may be able to raise demand without suffering from adverse selection, all the while dulling the incentives for price competition. While the implications of these findings are directly relevant to the marketing of consumer goods and services in the for-profit sector, they may also be relevant for the design of socially oriented programs, such as health care or retirement savings plans. Through increased focus on the marketing of their programs, governmental agencies may achieve broader participation without having to solely rely on greater financial incentives.
Since the framing of any initiative, program, or product can be just as important as the actual terms of the offer, attention should be paid to understanding these effects in the formation of public policies. The authors suggest that standard economic models may be missing some important, but complex, drivers of choice, requiring a deeper understanding of the specific contexts in which a particular psychological driver is likely to be relevant and the specific contexts in which it is not
-- Les Picker