Appl Ex 5r

Application Exercise 5r: Anchoring and the iPhone 14

  1. An oligopoly is a market structure characterised by a few dominant sellers that combined possess an overwhelming share of total sales in a specific market. Further, there are high barriers to entry and products can be differentiated or homogeneous. Competition is largely based on non-price factors such as service, image, reliability, the product’s aesthetics etc.
  1. Market power describes a situation where sellers have price setting ability in the market. In a market structure such as an oligopoly where there are only a few sellers due to high barriers to entry, competition is based mainly on non-price factors. Here sellers have the power to set prices without fear of losing a significant number of sales. Further, there is likely to be a degree of collusion between sellers whether tacit or otherwise. Therefore, in this market structure, sellers typically restrict supply and raise prices to maximise profit.
  1. Low price elasticity of demand means that the quantity demanded (QD) is not very responsive to a change in price. For example, an increase in price yields a less than proportional decrease in the QD. Conversely, a decrease in price yields a less than proportional increase in the QD. In other words, the percentage change in the QD is less than the percentage change in price. In simple terms, a product with a low PED means that consumers are not very responsive to a change in its price.
  1. This is because these consumers have strong brand loyalty (e.g., an affinity or passion for the Apple brand). This strong brand loyalty is a result of effective marketing strategies and the covetable nature of the technology.
  1. The consumer surplus refers to the difference between the amount that a consumer is willing and able to pay for a product and the amount that they actually pay. For example, if a consumer is prepared to pay $3,000 for an iPhone 14, but ‘only’ pays $2769, then he/she is enjoying a consumer surplus of $231 (i.e., $3,000 – $2769).
  1. High-value consumers are willing to pay a relatively high price whereas low-value consumers are unable or unwilling to pay a relatively high price. At product launch, Apple will use its market power to set a high price for the iPhone 14 to extract as much of the ‘consumer surplus’ as possible from high-value consumers in order to maximise revenue. Over time, Apple will lower the price of the iPhone 14 to generate sales from the low(er)-value consumers.
  1. According to Harvard University’s Program on Negotiation “…. Anchoring is a cognitive bias that describes the common human tendency to rely too heavily on the first piece of information offered (the “anchor”) when making decisions. During decision making, anchoring occurs when individuals use an initial piece of information to make subsequent judgments. Once an anchor is set, other judgments are made by adjusting away from that anchor, and there is a bias toward interpreting other information around the anchor.”  The price tag of $AUD 2769 for the iPhone Pro Max 14 effectively acts as an “anchor” for the entire iPhone product line. Although many consumers are not prepared to pay this large sum of money for an iPhone Pro max 14, the hefty price tag serves to change the way they think about Apple’s other product offerings. That is, it essentially makes the prices of other iPhone models more attractive, such as the 512GB iPhone 13 at $AUD 1749 or the 512GB iPhone Plus 12 at $AUD 15799. So, anchoring can be used to generate more sales of other products in the iPhone product line.

  1. Thinking fast is where very little mental effort is expended when making decisions. It is the opposite of thinking slow, which describes the careful consideration that typically goes into making big decisions.
  1. People use heuristics or mental shortcuts as a substitute to thinking hard about a decision. People resort to heuristics because they are generally busy, lead complicated lives and are time poor, making it impossible to analyse the minutiae of every consumption decision.
  1. Although heuristics, such as the use of anchors, can be a good thing in the sense that they ‘speed up’ the decision-making process, they can also lead to irrational or anomalous choices. This occurs when consumers’ judgements are unduly affected by an arbitrary starting value or anchor. The end result can be decisions that fail to maximise consumer satisfaction or utility at the lowest possible cost.