Heuristics: Anchoring Pt.3

This is the final segment on the anchoring heuristics – today, we will move on to look at how companies like Starbucks can detach themselves from anchors and how the minimum wage could act as a potential anchor

Companies can also use this theory and practice to break free of specific anchors. One such case is with Starbucks, which has relatively higher prices than their competitors, such as Dunkin’ Donuts. By creating a unique, coveted store ambience and carefully selected product names, they have differentiated themselves from the competition, and so loyal Starbucks customers ignore the lower prices at Dunkin’ Donuts, negating the effect of the anchoring heuristic.[1] This is the primary reason why Starbucks always prices their coffee higher than Dunkin’ Donuts, such as the $2.10 grande hot coffee at Starbucks compared to a medium one at Dunkin’ Donuts for $1.89 – loyal Starbucks customers are conditioned and willing to pay more even though the coffee is essentially the same quality. Even the names of the sizes reduce the likelihood of comparing the two goods. Although a grande is the same size as a medium, it sounds as if it contains more coffee and is ‘fancier’ or higher quality, therefore justifiably the higher price in the consumer’s eyes.

One scenario in which anchors can form unknowingly and cause unforeseen problems is with the minimum wage. The political pressure behind introducing the minimum wage started gaining traction in the early 20th century, during the Great Depression, where firms would exploit the deprived workers by paying very close to nothing. This led to introducing a national base wage rate, which is still in place now, benefitting low-income workers in today’s society. There is no denying the help that the minimum wage has provided, but it has also made it harder for these workers to earn more as they get older and their career progresses, as the value of the minimum wage begins to act as an anchor. This has also affected people in jobs that require more skills and education, as they are not being paid that much more than the minimum wage. Employers might involuntarily use the minimum wage as an anchor, unconsciously causing employers to pay lower wages and cutting the possible disposable income of millions of workers. Obviously, this only causes problems for low-paid jobs in general, but seeing as a large proportion of the population are employed in such sectors, the economic impacts become widespread.

This is exemplified when you use the concept of Aggregate Demand, a crucial and fundamental part of macroeconomic theory – it is influenced by four main factors: consumption, investment, government spending, and net trade. If the minimum wage falls, a large proportion of the population are being paid less (not only those on minimum wage but also those whose wages have been affected by the minimum wage acting as an anchor), so they have a lower disposable income, which would reduce how much they purchase and thus causes a fall in consumption. This would cause AD (Aggregate Demand) to shift to the left on the AD-SRAS graph, which you can see below. A fall in national output occurs from Ye to Y2 and a fall in the price level from Pe to P2. This means that the economy is shrinking, and deflation has begun, which can cause further problems such as a deflationary spiral.

In addition, now that consumers earn less and buy fewer goods and services, firms are making less revenue, which is worsened by prices falling through deflation – firms will have to lower their prices and thus make lower profits. This reduces how much they can spend on capital like machinery and factories, so investment, which is another factor affecting AD, also falls. This causes another leftward shift in AD, causing further deflation and economic decline. Firms will have to cut wages and lay off more workers to prevent losses, cutting disposable income and creating another fall in consumption and AD. This can repeat to create a negative multiplier effect, which needs to be stopped before it cripples the economy, and so the government will need to step in. However, as earnings, consumption and firm revenue have all fallen, the government is making much less in tax revenue –specifically, income tax, VAT (value-added tax on goods and services) and corporation tax. This means that government spending would decrease, causing even further falls in AD, adding to the negative multiplier effect and making it difficult to reverse the damage.

Although this may seem far-fetched, it highlights how a fall in the minimum wage could be catastrophic for the economy due to it acting as an anchor – if the anchor is lower, average wages will fall alongside the minimum wage. However, this also means the inverse is true – a rise in the minimum wage can also increase average wages due to a higher anchor and create a positive multiplier effect that can cause the economy to prosper. This is one of many relevant methods of applying behavioural economics to the real world and using it to help governments improve the economy through their policy decisions.

[1] The Chicago School of Professional Psychology – ‘5 Examples of Behavioural Economics in your everyday life’ – Rebecca Koch, March 2018


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