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Why the Price Is Rarely Right


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Consumers think they know what something is worth, but sellers have evolutionary advantages

Priceless:

The Myth of Fair Value

(and How to Take Advantage of It)

By William Poundstone

Hill and Wang; 352 pp; $26.99

You are hopelessly gullible. You have no firm idea of what anything should cost, so advertisers, marketers, and salespeople regularly lead you astray. If you're sure that you're too smart for their pricing tricks, that makes you dumber still, because you don't even realize you're being exploited.

That's pretty much the message of William Poundstone's Priceless: The Myth of Fair Value (and How to Take Advantage of It). Poundstone, a Los Angeles-based author of 11 non-fiction books, isn't indignant about all the obstacles to value. He's intrigued. For him, prices are fascinating because they sit squarely at the intersection of our desires and the objects of desire. What we're willing to pay reveals much about the chaos inside our skulls.

In Econ 101, price is a clean concept. People know how much various things are worth to them, and they line up those personal valuations against what sellers are asking. In reality, writes Poundstone, "the numbers that make our world go around are not so solid, immutable, and logically grounded as they appear. In the new psychology of price, values are slippery and contingent, as fluid as the reflections in a fun-house mirror."

People's cluelessness about what goods are worth to them makes them vulnerable to what behavioral economists call "anchoring." As every luxury retailer knows, an anchor is a high-priced product that may never sell but "makes everything else look affordable by comparison." Poundstone observes that in the midst of the recession, Ralph Lauren (RL) was selling a "Ricky" alligator bag for $14,000. (Update: It's now $16,995, making Lauren's Tiffin Bag a steal at just $2,595.) And anchoring works: Williams-Sonoma (WSM) once offered a fancy breadmaker for $279. Then it added a $429 model. The costly model flopped, but sales of the cheaper one doubled.

Poundstone's publishers make amusing use of anchoring right on the dust jacket of Priceless. The book's title is printed on a price tag that appears to be attached to the cover. The tag says the original price of the book was $559.99. Not true, but even so, the sky-high number somehow reflects well on the book's actual price—$26.99. Well played, jacket designer.

The power of anchoring explains everything from why plaintiffs' lawyers often demand ridiculous sums for pain and suffering (the more you ask, the more you get) to bubbles in the stock market (investors become anchored to high and rising prices no matter how out of line with fundamentals).

Poundstone is far from the first to spot and write about pricing tricks, some of which are centuries old. Recently we have seen a spate of books by pioneers of behavioral economics such as Richard Thaler and Dan Ariely, both of whom Poundstone liberally quotes. Where he excels is in explaining why age-old pricing tricks work long after we should have wised up. Citing psychological research, he says the human brain evolved for success in a world blessedly free of teaser rates, rebate coupons, and late-night infomercials. Optimized for quick decision-making, the brain "constructs desires and beliefs on the fly," writes Poundstone. "This," he says, "can lead to inconsistent prices and choices" that are ripe for exploitation.

Aside from his main counsel—know your limitations—Poundstone sprinkles Priceless with bits of consumer advice, like: Be the first to name a price in a negotiation, and don't worry about being overly reasonable. Also: To neutralize the effect of anchoring on your judgment, stop and think of all the reasons that the proffered price might be unreasonable.

Pricing is a richer subject than you might imagine. The smile that creeps onto your face when a shameless marketing gambit reminds you of something you read in Poundstone's book? Priceless.

Coy is BusinessWeek's Economics editor.

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