By Carl Coates
Humans are short-cutting machines. Gut feelings, intuition, and experience all play a role in our decisions. In terms of deciding what to buy and how much to pay, we really do lean on our mental bypasses. All students of economics learn early on about the law of demand which describes how people act in the face of budget constraints. Though not earth shattering, it’s a given that when people see prices for two virtually similar goods, we choose the one that is cheaper. The intersection of human’s seeking shortcuts and budget constraints manifests in what we call Left-Digit Bias. And once you see it, you can’t unsee it.
Take Me Out to the Ballgame
I recently attended a Chicago Cubs baseball game like I do every year. I’m always a bit curious about what’s going on with the ballpark food and beverage scene to see if there’s something new worth trying out. New items are often introduced over the years, a sort of “food churn”, if you will. This season’s additions include a Bao Wow Dog and a series of gluten-free options at one of the concession stands. Other items are quietly retired. The 2009 North Side Giant Twist, a hulking soft pretzel, is one such food item I’d rather forget. I dubbed it the Free Agent Knot Not, a nod to the pricey signing of an underperforming and controversial outfielder whose arrival coincided with its fluffy, carb-laden launching. Good riddance to both.
Of course, like many an economically inclined thinker, I also spend some time surveying the prices: hot dogs, Italian ice, soft-serve in a helmet, soft drinks, adult beverages, etc. This makes me wonder about how the concessions folks arrived at those particular prices, how the products are marketed and sold and, of course, the role of consumer demand and price. (No really. I’m mostly there for the ball game, but chewing on prices while I munch on my nachos is an extra bonus for me.) At this game, I noticed a new trend. All the prices ended in a $0.99. I mean ALL the prices. And, as I attend a few games as season, I also noticed prices were all higher than last year. These price increases are not uncommon. But, previous to this year, many of the concession prices ended in $0.50 or were whole numbers. What was going on? This sent shockwaves through my empirical lobe. It was time to optimize, unpack this and write another perfect pairing.
Behavioral Economics: Econs and Humans
I have written about Behavioral Economics in a previous article and despite sounding redundant, it’s worth doing a quick review of some simple principles behind the basis of this sub-field of economics. At the crossroads of psychology and economics, behavioral economics can be looked at as an extension of the rational, consistently optimizing human which formed the basis of economics as a field. However, it should be noted that economists had long acknowledged humans’ fallibility in decision making. This formal awareness goes back as far as Adam Smith’s noting of the role of passions influencing choices. But, it is Kahneman and Tversky’s famous 1979 Prospect Theory paper that is often seen as the early challenge to Expected Utility Theory, the reigning model of rational choice in economics. It also provided an alternative descriptive model for understanding how humans make decisions.
Behavioral economics is not a footnote to modern economic thought. In fact, one could argue it’s increasingly at its core. It’s asking better questions about why humans make decisions. And it turns out the answers are messier and more interesting than what textbooks once suggested. Essentially, people may seem like they’re not optimizing from the outside, but behavioral economics shines a light on other forces at play. UChicago’s own Professor John List has captured these ideas in four core principles that describe how humans make decisions.
John List’s Four Principles of Economics:
- People try to choose the best feasible option, but sometimes they don’t succeed.
- People have self-control problems.
- When people make choices, they tend to focus on what’s most noticeable or obvious.
- Although we mostly care about our own payoff, we also care about the outcomes of others.
The 3rd principle is the one related to my pricing observations from the ballpark. What’s most noticeable or obvious to humans about prices? The left-hand digits, of course. It turns out that the stuff on the other side of the decimal point may not matter so much to us.
Lyft, Demand curves and $8…er…$7.99 Peanuts
Have you ever noticed that prices ending in .99 are everywhere? This isn’t a coincidence. It’s a carefully leveraged quirk in how the human brain processes numbers. When we read a price like $7.99, our minds anchor heavily on the leftmost digit, the 7, and tend to underweight the cents. This is called left-digit bias. The result is that $7.99 feels meaningfully cheaper than $8.00, even though the actual difference is just one penny. Economists classify this as a cognitive bias because it causes people to make decisions that deviate from what pure logic would predict.
John List and his colleagues put numbers to this phenomenon in a striking way, studying hundreds of millions of ride requests on the Lyft platform. They found that demand dropped sharply and discontinuously, or abruptly, as opposed to gradually, whenever a price crossed a whole-dollar threshold. In fact, they estimated that roughly half of the entire drop in consumer demand between, say, $7.00 and $8.00 happens at the single penny crossing from $7.99 to $8.00, even though that’s only a one-cent change. The other half is spread across the remaining 99 cents of actual price reduction. In other words, a one-cent increase from $7.99 to $8.00 had the same impact on demand as cutting the price from $7.99 all the way down to $7.00. This is a powerful reminder that consumers don’t respond just to how much something costs, they also respond to how the price looks.
So, you can imagine my excitement at seeing $7.99 peanuts at the ballpark. (Well, my wallet was less excited. Those peanuts don’t cost peanuts.) It was left-digit bias in action, and it was everywhere! Left-digit bias is generally understood as a product of the anchoring heuristic. When we see a price, our brains latch onto the leftmost digit first. That number sets the tone, and everything to the right of it gets far less attention than it may deserve. The digits to the right — the cents — get processed less carefully and carry less psychological weight than their mathematical value warrants. Furthermore, the left-digit bias applies to the leftmost digit that matters most to the buyer. In other words, there can be an effect on quantity demanded between $7.50 versus $7.49 as well, if the tens place is the left-digit of importance.
Ballgame over!
As I walked back to my seat with my $7.99 bag of peanuts in hand, I was excited to see another economic concept in action. The fact is that this overpriced bag of peanuts connects to decades of research on human behavior. Economics doesn’t just explain what people buy, it explains how people think. And once you start seeing the world through that lens, a bag of peanuts at a ballpark becomes a window into something much larger. There’s a power to behavioral economics because it reveals the patterns of our irrationality and makes them predictable. Understanding how and why people diverge from rational behavior can teach us something essential about what it means to be human.
And, that’s why economics is for everyone.