For centuries, traditional economics has been built on a simple, yet powerful assumption: that humans are rational beings who make decisions to maximise their own self-interest. While this model is useful, it doesn't always capture the full picture of human behaviour. Enter behavioural economics, a field that combines insights from psychology and economics to understand why we sometimes make decisions that seem illogical.
A Simple Lottery Ticket Question
Imagine you're offered a choice between two lotteries:
- Option A: A 100% chance to win £1 million.
- Option B: An 89% chance to win £1 million, a 10% chance to win £5 million, and a 1% chance of winning nothing.
Most people would choose Option A. It’s a sure thing. The certainty of becoming a millionaire is incredibly appealing, and the risk of winning nothing in Option B, however small, is enough to put us off.
Let's Change the Odds
Now, consider a different choice:
- Option C: An 11% chance to win £1 million, and an 89% chance of winning nothing.
- Option D: A 10% chance to win £5 million, and a 90% chance of winning nothing.
In this scenario, a significant number of people switch their preference to Option D. Why? The chances of winning in both scenarios are low, so the allure of the much larger prize in Option D becomes more attractive. This is the essence of the Common Ratio Effect.
The Common Ratio Effect Explained
If we were purely logical, our preference between the two sets of choices should remain consistent. The first choice (A vs B) and the second choice (C vs D) are mathematically related. Option C is simply Option A with the probability of winning reduced by a common ratio (multiplying both by 0.11), and Option D is Option B with its probabilities also reduced by the same ratio (multiplying by 0.11).
The fact that people switch their preference from the 'safe' option to the 'risky' option shows that we don't treat probability in a linear, logical way. When the chances of winning are high, we are risk-averse and prefer certainty. But when the chances of winning are low, we become risk-seeking and are more attracted by the size of the potential prize.
Why This Matters for Your Business
Understanding these cognitive biases is not just an academic exercise. It has real-world implications for how you design your products, price your services, and market your brand. Are you framing your offer in a way that appeals to your customers' desire for certainty? Or are you leveraging the appeal of a long-shot, high-reward outcome to drive engagement?
By understanding how people *really* think, you can build a business that resonates on a deeper, psychological level. And that's the first step towards building something people truly want.
Ready to move beyond guesswork and understand the real drivers of customer behaviour? Start validating with Qurate today.