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The Price Precision Effect: Evidence from Laboratory and Market Data

Johnson Graduate School of Management, Cornell University, Ithaca, New York 14853
Applied Economics and Management, Cornell University, Ithaca, New York 14853
Johnson Graduate School of Management, Cornell University, Ithaca, New York 14853
mkt27{at}cornell.edu
dhs29{at}cornell.edu
kadiyali{at}cornell.edu

We examine two questions: Does the roundness or precision of prices bias magnitude judgments? If so, do these biased judgments affect buyer behavior? Results from five studies suggest that buyers underestimate the magnitudes of precise prices. We term this the precision effect. The first three studies are laboratory experiments designed to test the existence of the precision effect and examine the underlying psychological processes. In Study 1, we find that precise prices are judged to be smaller than round prices of similar magnitudes. For example, participants in this experiment incorrectly judged $395,425 to be smaller than $395,000. In Study 2, we show that precision is more likely to affect magnitude judgments under conditions of uncertainty. Study 3 demonstrates that manipulating prior experience with the pattern of roundness and precision in numbers can moderate the precision effect. Studies 4 and 5 examine whether the precision effect influences buyers' willingness to pay for negotiated purchases (e.g., houses). In Study 4, we conduct an experiment on a nationally representative sample of homeowners to demonstrate that participants are willing to pay more for houses when the sellers use precise (e.g., $364,578) instead of comparable round (e.g., $365,000) prices. In Study 5, we analyze data from residential real estate transactions in two separate markets and find that buyers pay higher sale prices when list prices are more precise. These empirical results enrich our understanding of the psychological processes that underlie price magnitude judgments and have substantive implications for buyer and seller behavior.

Key Words: behavioral pricing; numerical cognition; roundness; precision; heuristics; biases
History: Received: September 4, 2007; accepted: April 14, 2009.