Cause of misjudgment № 16
Contrast-Misreaction Tendency
We judge things by contrast with what's next to them rather than by their true value — which can be exploited to make bad deals look good.
The nervous system registers contrasts, not absolutes. We don’t perceive a temperature so much as a change in temperature; we don’t judge a price so much as a price relative to whatever price we just saw. This works fine for navigating the physical world, but it systematically distorts judgment whenever a clever counterparty controls what you compare against.
The retail trick is everywhere. Show a customer a $1,000 suit first, and the $200 tie offered right after seems trivial — even though $200 for a tie is a lot. Real-estate agents do the same by showing a couple of overpriced, run-down houses before the one they want to sell, so the target property looks like a bargain by contrast. The number hasn’t changed; the reference point has, and the reference point is doing the persuading.
The more dangerous version is gradual: a deterioration that would be obvious if it happened all at once goes unnoticed when it arrives in small steps, because each step is only a slight contrast with the last. Munger invoked the (apocryphal but instructive) image of the frog that will jump out of hot water but boil to death if the water heats slowly. The defense is to evaluate things against their actual worth or against a fixed standard, not against whatever was placed beside them — and to watch for slow drifts by comparing where you are now to where you were a long time ago, not to yesterday.
