Picture yourself on a beach. You are basking in the hot sun, feeling incredibly thirsty. Fortunately, there’s a bar at the resort where you’re staying. It’s pricey, but it’s just a few steps away. How much are you willing to pay for a cold beer?
Classically trained economists would tell you your answer to this question should be the same no matter where you are, be it a Walmart in Des Moines or a resort in Key West. After all, economic theory assumes rational behavior. Why pay more money if the actual beer itself is the same? Psychologists, however, know people’s perceptions of value often shifts based on contextual cues, such as who you’re with and where you are. As both psychologists and resorts know, how much people are willing to pay for a beer will likely be higher at a fancy resort than an average grocery store.
Not so for low-income individuals. At least, according to a recent article published in Psychological Science by Anuj K. Shah, Eldar Shafir and Sendhil Mullainathan. In a series of studies, Shah and colleagues examine how scarcity—not having enough of a precious resource such as time or money—affects people’s perceptions of value.
When money is short, the utility bill and rent payments are on the top of one’s mind…Somebody contemplating purchasing a beer compares the beer with other budgetary demands, like tomorrow’s lunch or bus fare.
They asked over 2500 people how much they would be willing to pay to enjoy a beer on the beach. For half the participants, the beer is being purchased at a local grocery store. For the other half, at a fancy resort. They wanted to see how much people were willing to pay for the same item in two contexts. Shah and his colleagues found that higher-income participants offered to pay a higher price for beer from the resort than from the grocery store. Interestingly, lower-income individuals on average were not more willing to pay more for beer at the resort than at the grocery store. In other words, they offered to pay the same price for beer, regardless of where they were buying it.
The authors suggest that these results can be explained by scarcity. According to classical economic theory, we make decisions to prioritize our most pressing needs when resources are limited. Shah and his colleagues explain, “When money is short, the utility bill and rent payments are on the top of one’s mind…Somebody contemplating purchasing a beer compares the beer with other budgetary demands, like tomorrow’s lunch or bus fare.” Therefore, lower-income individuals are less likely to care about where the beer is being purchased. Even at a resort, $8 is way too much money to spend on a beer. Buying that beer means $8 less to spend on something more important. In this regard, scarcity anchors judgments of value and explains why low-income individuals value the beer more consistently.
On the other hand, high-income individuals are willing to pay more for the beer from the resort, a finding that reveals an important discovery about the concept of scarcity. While economic theory assumes that everyone experiences scarcity of resources, this is not the psychological reality for many people. The wealthy may not feel constrained by money and therefore, are less likely to adopt a mindset governed by not having enough. Instead, they make what economists would call less “rational” spending decisions, based on factors such as what their friends are doing, what seems like a good deal, and what looks the most aesthetically appealing. For example, what must be extremely frustrating to classic economists, marketers know they can rely on decoy pricing to boost sales. After all, people are predictably more likely to buy a shirt priced at $50 after a 70% markdown than if the shirt was priced at $50 to begin with.
In fact, when asked to explain the rationale behind their prices for beer, higher and lower-income participants again demonstrated differences in their perceptions of value. Lower-income participants were more likely to say their prices were influenced by other things they wouldn’t be able to buy if they used the money for beer. This response represented the kind of trade-off thinking that Shafir and his colleagues expect under the scarcity mindset. For poorer people who have less money to spend, buying one thing often means not being able to buy something else. Alternatively, higher-income participants were more likely to say their prices were influenced by where the beer is being purchased. Less constrained by scarcity, they based their judgements of value on contextual cues (e.g., location of beer purchase) that should have been inconsequential under classic economic thinking.
This research provides practical implications for policy initiatives targeted towards the poor. For example, malaria remains to be a big problem in many African countries. In Kenya, 28 out of 34 million people are at risk for contracting malaria. Policymakers have tried to nudge people to purchase mosquito bed nets by highlighting their benefits. However, this research reveals that framing interventions are unlikely to change the purchasing behaviors in low-income families. Instead, the most effective strategy may simply be to decrease prices. Because poorer communities are likely to consider the opportunity costs of purchasing a mosquito net, pricing strategies are especially important.
Current findings also extend to payday loans, for which annualized rates sometimes skyrocket to upwards of 500%. Policymakers have recommended changing the presentation of interest fees (as either annualized or bi-weekly interest rates) to influence borrowing behavior. However, this framing intervention may not affect poor borrowers because they are less vulnerable to contextual cues. Instead, presenting actual fee amounts, rather than interest rates, may be more effective in bringing to mind the things they would have to give up to pay off the loan.
In addition to the “beer on beach scenario,” Shah and his colleagues also examined the extent to which scarcity might affect how people judge value in non-financial situations. In a dieting example, researchers assumed that dieters adopt the scarcity mindset, whereas non-dieters do not. Participants were either prompted to think about the calories they consumed in a day or in a week. Next, they rated how fattening a large order of fries from McDonalds felt.
For non-dieters who thought about how much they ate in a week, the fries didn’t sound so fattening. When the reference point was a day, the fries seemed like a lot more. Dieters, on the other hand, thought the large order of fries seemed equally fattening in both contexts; for the dieters, who were likely trying to stick to a limited number of calories, eating fries might mean having to give up a healthy but more substantial meal.
In a third study, rather than using predetermined levels of scarcity (e.g., income level, dieting habits), Shah and his colleagues experimentally manipulated scarcity by imposing time constraints. Half the participants were given 75 seconds to play the trivia game Family Feud, while the other half were given 250 seconds. Participants played as many rounds as they could with their allotted time. At the end of the game, participants either thought about their time budget per round or their time budget for the overall game and then rated how costly it felt to lose 10 seconds. Consistent with findings from the other studies, participants that were given less time said it was equally costly to lose 10 seconds. Participants that were given more time perceived the loss as more costly when considering the time budget per round than in the overall game.
While in these scenarios, scarcity helped low-income individuals stay on budget, stick to their diets, and manage their time, in a number of studies, Shah and his colleagues have shown how scarcity exacerbates the psychological biases all humans tend to have. In their 2012 article published in Science, Shah and colleagues found that scarcity leads to attentional neglect. Those lacking a precious resource, like time or money, often experience tunnel-vision, focusing their attention on their most pressing problems while neglecting other important concerns. For example, when low-income individuals take high-interest payday loans, they are mostly focused on paying off their current bill, even though such a loan results in higher expenses in the long term. Attentional neglect may also explain why chronic procrastinators seem consistently pressed for time, failing to meet basic needs such as eating, sleeping, or exercising. The scarcity mindset is complex. The same focus and attentional shifts that allow low-income individuals to ignore contextual cues may simultaneously lead to the neglect of other important problems.
In an interview with The Psych Report, Shah said, “It is not clear that scarcity or poverty is going to lead people to align with all principles from economics. In fact, it almost certainly doesn’t. Often, it pushes them in the opposite direction. But here, at least we see that when people are thinking about the value of things or what experiences actually cost them, they are better at coming up with internal landmarks for what something costs. They just have more demands on their budget that come to mind.”
Overall, the present research finds the nexus between economic theory and psychological reality. Scarcity sharpens our internal judgments of value, and blurs distracting contextual cues. Scarcity helps to explain why for some, the ice cold beer from the resort is worth an extra five dollars. But for others…a beer is a beer is a beer.
Disclosure: Eldar Shafir is member of The Psych Report’s Advisory Board.