What Is a Relativity Trap?
A relativity trap is a psychological or behavioral trap that leads people to make irrational purchases. It is one form of the anchoring effect. The human brain works in a relative way when making comparisons and finds it difficult to compare across different categories. Savvy marketers frequently seek to exploit this, coaxing consumers into pursuing a spending decision that maximizes their profit. Behavioral economists have argued that this leads consumers to make purchases that are not necessarily in line with their true preferences.
- Relativity traps are psychological or behavioral traps that cause people to make irrational buying decisions.
- When making comparisons, people may find it difficult to compare across different categories.
- A relativity trap is related to anchoring, a cognitive bias that describes when an individual relies on or fixates on an initial piece of information to make decisions.
Understanding Relativity Traps
Our minds are generally programmed to make buying decisions based on comparisons. When we need to purchase a specific item, we tend to look at how much each shop charges to determine which is offering the best deal. Sometimes this approach can lead us to think irrationally and make bad decisions.
Customers often do not know the actual market price or seller cost of the product or service they wish to purchase and instead rely on the prices listed by a shop or suggested by a salesperson.
The concept of a relativity trap is related to the phenomenon of "anchoring," a cognitive bias that describes when an individual relies on or fixates on an initially available piece of data or information in the decision-making process. Often, the first number we see clouds our perception of everything that comes after. Anchoring is often employed by retailers to fool consumers into believing that they are getting a good deal, the so-called "anchoring trap." Innumerable experiments on this subject find that the relativity trap is a potent issue that affects financial decisions for a great number of people.
Examples of a Relativity Trap
A common example of the relativity trap is the pricing models adopted by most clothing stores. If the regular price of a pair of jeans is $40, the store will show the price as $100 but subsequently discount them by 50% so that the "sale" price is now $50. The buyer thinks they are getting a bargain when in reality the store has charged them an extra 25% on the item (the $10 difference).
Even if the buyer’s true underlying preference is for a pair of jeans at no more than $40, behavioral economists claim that they will often still purchase the jeans at $50 because of the perception that they are actually saving money because of the sale price.
For another example, commuters may pay $25 for an hour of “discount” parking, if the first lot they come across charged $30, even if $20 parking may be available elsewhere (unknown to the commuter). If the same owner owns all three lots, they may even deliberately follow this pricing strategy in order to capture some consumer surplus through effective price discrimination.
A similar example comes from food service. Suppose a restaurant offers a value burger for $1.99, a regular burger for $2.99, and a premium burger for $4.59. The relativity trap suggests that most people will opt for the regular burger, perceiving it to be the best value or price relative to the quality of the burger.
The consumer may assume that the value burger is inferior because of its low price and that for “just a dollar more” they can enjoy a higher quality burger. On the other hand, they may think that the premium burger is not worth its elevated price because of how it compares to the other offerings, at almost double the cost of the regular burger. However, if the price of the premium burger is slashed to $3.59, a substantial number of people will choose it on the grounds that it is worth paying an extra 60 cents for a premium burger. If the additional benefit that the consumer receives from the enhanced quality of the premium burger is worth less than 60 cents, then this is the relativity trap at work again.
The relativity trap is a common pitfall in investing, too. Certain valuation multiples may make a company look like a bargain compared to its peer group. In reality, this just might be an illusion—the companies may be vastly different; its price compared to a historical precedent may not account for changes in the marketplace or the multiple may fail to factor in something important, such as the precarious state of its balance sheet. In investment circles, these relativity traps are known as "value traps."
The relativity trap is also apparent when making comparisons across dissimilar types of goods. For example, consider a consumer who sets out to buy a basic bike on a limited budget of $150. Assume they are also looking casually for a set of golf clubs to replace an old set, albeit less urgently.
While shopping for the bike, the buyer comes across a great set of clubs that have been marked down 50% and are now priced at $200. The relativity trap may well lead the consumer to buy the golf clubs on the justification that it is an opportunity not to be missed. Suddenly, the consumer has gone $50 over budget and failed to purchase the one thing they wanted originally—the bike.
If the consumer actually values the golf clubs at less than the $200 they paid or than the $150 they had budgeted for the bike, then they will be left dissatisfied. However, if the consumer values the golf clubs at least as much as the $200, then they clearly also value them more than the bike (for which they were willing to pay only $150).