When JCPenney's decided to ditch sales in favor of "fair and square pricing," removing labels that said "$100 marked down 40 percent!" for a simple $60 price tag, what happened?

"Within a year, JCPenney lost an amazing $985 million and [CEO Ron] Johnson was out of a job. Almost immediately after his firing, the list price of most items at JCPenney rose by 60 percent or more," report psychologist Dan Ariely and writer Jeff Kreisler in an excerpt from their new book Dollars and Sense on the TED ideas blog.

The incident proves that people really love a bargain, but there's only one problem with that according to Ariely and Kreisler. Discounts tend to make us dumb.

Discounts are a magic potion for stupidity.

Take the case of a shirt marked down from $100 to $60 versus one given an honest price of $60 from the start. Rationally speaking, it should make no difference to shoppers how the shirt came by its price - if it's worth $60, it's worth $60 - but that's not how our brains actually work.

Instead of focusing on the ultimate value of something, which is difficult verging on impossible, we tend to determine if something is worth the price by comparing it to other things. "If we compared everything to all other things, we'd consider our opportunity costs and all would be well. But we don't. We compare the item to only one other (sometimes two)," explain Ariely and Kreisler. Manipulating these comparisons is how sales make us so dumb (and also why they can make clever marketers wealthy).

Do you really need that giant vat of shoe polish? Who cares if it's way cheaper per unit than the usual size! Is $200 a reasonable amount to pay for a slightly different upholstery for your car seats? Who cares when you're already shelling out $20,000! By encouraging thinking like this, sales nudge us to make the wrong sorts of comparisons - not 'Is this a good thing to spend my money on versus everything else I could do with the same amount?', but 'Is this shirt (or shoe polish or car upgrade) worth less than it would have been some other time or less than I was thinking about spending?'

Or as Ariely and Kriesler bluntly put it: "Discounts, it seems, are a potion for stupidity. They dumb down our decision-making process. When an item is 'on sale,' we act more quickly and with even less thought than if the product costs the same but is marked at a regular price." 

Forewarned is forearmed.

In the lengthy post Ariely and Kriesler go on to explain that the same sort of half-baked comparisons can compromise not just our finances, but our happiness too if we start measuring ourselves against others with the same lack of consideration. But that's a longer discussion for those interested in taking a deep dive into the subject with the book.

The immediate lesson is clear and useful (particularly as the holiday shopping season gets into full swing) - sales are likely to drive you to make irrational decisions about money that you'll soon regret. But you can fight back. In a quick interview, Ariely suggested three strategies to shop smarter:

  1. Make the pain of paying work for you. "When we spend money, we sometimes think about opportunity cost and sometimes we don't. When we think about the opportunity cost we suffer more," explains Ariely, "so if at the end of the meal we pay with a credit card rather than cash, it's less painful." (High-tech alternatives like Apple Pay are even less painful.) Therefore, if you think you're overspending in a particular area like clothing or restaurants, go low-tech and force yourself to pay in the most painful way that's practical.

  2. Think about relativity. Would you walk a couple of blocks on a sunny day to save $10 on a $15 dollar purchase? Of course you would. Rationally, that means you should put in the same effort to save $10 on a $1000 purchase. Most people, however, won't. But if you force yourself to consider things this way when you're buying big ticket items - What level of effort would I put in to save the same amount of money on a smaller item? - you can beat some of the bias that makes it easy to leave money on the table when buying something expensive.

  3. Make saving more visible. Our ancestors saved in livestock, so it was instantly visible who had the biggest herd. These days we use money, so it's much harder to tell how much people are saving, while it's easy to see what they're spending. Recognize this imbalance between the visibility of saving and spending, and that this leads us to pay too much attention to the latter. Then fight back. "Start talking to people about saving," recommends Ariely, who acknowledges this can be awkward but insists opening up will help you be smarter about money. ?