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Consider the experience of buying a stereo system, as conveyed by Shane Frederick, Nathan Novemsky, Jing Wang, Ravi Dhar, and Stephen Nowlis in an aptly named paper, “Opportunity Cost Neglect.” In their experiment, one group of participants was asked to decide between a $1,000 Pioneer and a $700 Sony. A second group was asked to pick between the $1,000 Pioneer and a package deal where for $1,000 they could get the Sony plus $300 to be spent only on CDs. In reality both groups were choosing between different ways of spending that $1,000. The first group chose between spending all of it on a Pioneer or spending $700 on a Sony and $300 on other things. The second group chose between spending all of it on a Pioneer or spending $700 on a Sony and $300 on music. The results showed that the Sony stereo was a much more popular choice when it was accompanied by $300 of CDs than when it was sold without them. Why is this odd? Well, strictly speaking, an unconstrained $300 is worth more than $300 that must be spent on CDs because we can buy anything with the unconstrained money—including CDs. But when the $300 was framed as being dedicated to CDs, the participants found it more appealing. That’s because $300 worth of CDs is much more concrete and defined than just $300 of “anything.” In the $300-for-CD case we know what we’re getting. It is tangible and easy to evaluate. When the $300 is abstract and general, we don’t conjure up the specific images of how we’re going to spend it, and the emotional, motivational forces on us are less powerful. This is just one more example of how when we represent money in a general way, we end up undervaluing it compared to when we have a specific representation of that money.1 Yes, CDs are the example here, which nowadays is like thinking about the gas efficiency of a stegosaurus, but the point remains: People are somewhat surprised when we simply remind them that there are alternative ways to spend money, whether it’s on a vacation or on a pile of CDs. That surprise suggests that people don’t tend to naturally consider alternatives, and without considering alternatives, we can’t possibly take opportunity costs into account. This tendency for neglecting opportunity costs shows us the basic flaw in our thinking.
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