CHAPTER • Uncertainty and Consumer Behavior 195 For example, goods purchased over the Internet often involve shipping costs Although small, these costs should be included as part of the good’s final price when making a consumption decision However, a recent study has shown that shipping costs are typically ignored by many consumers when deciding to buy things online Their decisions are biased because they view the price of goods to be lower than they really are.32 Whereas depending on rules of thumb can introduce biases in decision making, it is important to understand that they serve a useful purpose Frequently, rules of thumb help to save time and effort and result in only small biases Thus, they should not be dismissed outright Consumers often face uncertainty when making decisions, and lack the understanding of probability to make those decisions optimally (Consider the difficulty involved, for example, in calculating expected utility.) Consumers will often use rules of thumb when making decisions, but sometimes those rules of thumb can lead to strong biases THE LAW OF SMALL NUMBERS People are sometimes prone to a bias called the law of small numbers: They tend to overstate the probability that certain events will occur when faced with relatively little information from recent memory For example, many people tend to overstate the likelihood that they or someone they know will die in a plane crash or win the lottery Recall the roulette player who bets on black after seeing red come up three times in a row: He has ignored the laws of probability Research has shown that investors in the stock market are often subject to a small-numbers bias, believing that high returns over the past few years are likely to be followed by more high returns over the next few years—thereby contributing to the kind of “herd behavior” that we discussed in the previous section In this case, investors assess the likely payoff from investing by observing the market over a short period of time In fact, one would have to study stock market returns for many decades in order to estimate accurately the expected return on equity investments Similarly when people assess the likelihood that housing prices will rise based on several years of data, the resulting misperceptions can result in housing price bubbles.33 Although individuals may have some understanding of true probabilities (as when flipping a coin), complications arise when probabilities are unknown For instance, few people have an idea about the probability that they or a friend will be in a car or airplane accident In such cases, we form subjective probability assessments about such events Our estimation of subjective probabilities may be close to true probabilities, but often they are not Forming subjective probabilities is not always an easy task and people are generally prone to several biases in the process For instance, when evaluating the likelihood of an event, the context in which the evaluation is made can be very important If a tragedy such as a plane crash has occurred recently, many people will tend to overestimate the probability of it happening to them Likewise, when a probability for a particular event is very, very small, many people simply ignore that possibility in their decision making 32 Tankim Hossain and John Morgan, “… Plus Shipping and Handling: Revenue (Non) Equivalence in Field Experiments on eBay,” Advances in Economic Analysis & Policy 6: (2006) 33 See Charles Himmelberg, Christopher Mayer, and Todd Sinai, “Assessing High House Prices: Bubbles, Fundamentals and Misperceptions,” Journal of Economic Perspectives 19 (Fall 2005): 67–92 • law of small numbers Tendency to overstate the probability that a certain event will occur when faced with relatively little information