12. Does artificially inflating the reference price make sense? On the use of prospect theory

Almost everyone is familiar with catalog prices that have little to do with reality. When buying a new car, we know, for example, that the price should be negotiated, as in most cases a discount can be obtained. Such offers have visibly inflated prices and constant promotions. Is there any sense in giving an initial price that is too high, at which we will not sell the product, and continuously lowering it with promotions (e.g., 100 PLN permanently discounted by 25%), instead of immediately giving the final price of 75 PLN, since the customer will ultimately pay the same amount?

The main reason for using this practice is prospect theory. According to it, the decision-making process for a customer consists of two stages:

- the editing stage, when the customer determines a reference point against which to assess the consequences of a decision

- the evaluation stage, when the customer determines whether the current offer is a gain or a loss relative to the reference point¹.

When a store claims that the original price was 100 PLN, the reference point is set at this level, against which the product’s price is evaluated in the second stage. Then, upon seeing the current product price, the customer subconsciously assesses whether buying the product results in a gain or a loss. Thus, seeing a discount from 100 to 75 PLN, the price seems more attractive than if the starting price had been 75 PLN from the beginning. The pleasure from the purchase is greater because not only does the customer receive the product, but they also feel they have “saved” money. An artificially inflated initial price makes the customer believe they have gained from the purchase.

Additionally, thanks to the large margin associated with an inflated starting price, during negotiations (e.g., in the previously mentioned car purchase), the seller can offer different discounts to different buyers, thereby increasing their profit.

The same happens with some online courses. An increasingly common phenomenon is “limited-time” price reductions of courses by 90%, “only until midnight.” Of course, the clock resets at midnight and the countdown to the end of the promotion starts again. This way, the customer feels it is a special opportunity and is also under time pressure.

By choosing such a tactic, however, we risk that inflated price lists may easily lose credibility, making price anchoring ineffective. If we visit the online course page the next day and see the same time-limited offer, we will likely lose trust in such a website, or at best, conclude that the course price was artificially inflated.

[1] Kahneman and Tversky, 1979, Prospect Theory: An Analysis of Decision under Risk