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Mental accounting and consumer choice

Mental accounting and consumer choice. Richard Thaler Cornell University Presented by Scott Savage. Introduction. Standard Economic Theory Goal of consumer is to maximize Utility Should purchase set of goods (z) at prices (p) such that utility is maximized given Income constraints

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Mental accounting and consumer choice

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  1. Mental accounting and consumer choice Richard Thaler Cornell University Presented by Scott Savage

  2. Introduction • Standard Economic Theory • Goal of consumer is to maximize Utility • Should purchase set of goods (z) at prices (p) such that utility is maximized given Income constraints max U(z) s.t. Σ p1z1 ≤ I where z = goods, p = price, and I = Income

  3. Introduction • Mental Accounting Theory • Utility function U(x) is replaced by Value function v(*) from Prospect Theory developed by Kahneman and Tversky • Prospect theory aimed at describing or predicting behavior • Utility theory aimed at characterizing optimal behavior • Value function uses perceived gains and losses relative to a reference point instead of wealth or income as in traditional model

  4. Value Function v(∗)

  5. Coding Gains and Losses Integrated Segregated Outcomes are valued jointly v(x + y) Outcomes are valued separately v(x) + v(y)

  6. Possible Outcomes • Multiple Gains → x > 0 and y > 0 • v(x) + v(y) > v(x + y) • Segregation is preferred • Multiple Losses → - x and –y where x and y still positive • v(-x) + v(-y) < v(-(x + y)) • Integration is preferred • Mixed Gain → x > y • v(x) + v(-y) < v(x – y) • Integration is preferred - cancellation • Mixed Loss → x < y • v(x) + v(-y) ? v(x – y) • Segregation is preferred if v(x) > v(x – y) – v(-y) : “silver lining” • Integration is preferred otherwise – almost cancellation

  7. Compounding Rules • Segregate Gains • Integrate Losses • Cancel Losses against Larger Gains • Segregate “silver linings”

  8. Total Purchase Utility = Acquisition utility + Transaction utility • Value of the good compared to the outlay • Direct result of the trade of something to receive something else • Perceived merits of the “deal”. • Will depend on the price paid as compared to some reference price

  9. Transaction Utility Theory • Fairness determines the reference price • Fairness is dependent on the cost to the seller • Individuals will have a different reference price when expectations are different

  10. Budget Constraints Theory • Consumers typically use month to month time horizon instead of present value of lifetime wealth • Individuals or families will make purchasing decisions based on explicit or implicit budget constraints (k) for a category (i) given a specific timeframe (t) • High category k’s are typically goods that require more self-control from the consumer • Low category k’s are typically goods that are advantageous in the long run http://www.youtube.com/watch?v=sSSg3RkW8MI

  11. Marketing Implications • Compounding Rule • http://www.dell.com • Transaction Utility • http://www.amazon.com • Budgeting Constraints • http://www.thecoronabeach.com/

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