Mental accounting and customer choice- summary

Introduction

This paper discusses a new model of consumer behavior using a hybrid of cognitive psychology
and principles of microeconomics. Thaler realizes that all organizations have explicit and implicit
account systems, which often influence decisions in unexpected ways. The goal is to develop a
richer theory of consumer behavior than standard economic theory. There are several instances
where a mental accounting system induces an individual to violate a simple economic principle.
Violations include the principle of fungibility (money is not supposed to have labels) and the
tendency to give as gift items what the recipient would not typically buy for themselves. The
author notes that all models omit marketing variables except for price and product .

Mental Arithmetic

To understand the behavior of a consumer, the first step is to replace the utility function from
economic theory with the value function. The value function is assumed to be concave for gains
and convex for losses. It has a loss function steeper than the gain function.

Next, the author examines the question of how a join outcome gets coded as the value function
is defined over single, one-dimensional outcomes. Two possibilities are stated: integrated
(outcomes are valued jointly) and segregated (outcomes are valued separately). The author then
puts forth four principles:

a) Multiple gains: segregate gains,

b) Multiple losses: integrate losses,
c) Mixed gain: cancel losses against larger gains, and
d) Mixed loss: segregate “silver linings”.

The author conducts a small experiment using 87 undergraduate students who are presented
with pairs of either segregated or integrated outcomes and asked to decide which are preferable.
Four scenarios are used, each corresponding to the four principles noted above. Results proved
that for each item, a large majority of the subjects chose in the manner predicted by the four
principles.
A reference outcome is defined as the sum of what an individual is expecting and what he or she
instead obtains. This concept is used to model a buyer’s reaction to a market price that is different
from what he or she expected

Transactional Utility Theory

The author proposed a two-stage process to analyze consumer transactions. First, individuals
evaluate potential transactions (judgment process) and second, they approve or disapprove of
each potential transaction (decision process).

Two kinds of value are explored: acquisition utility and transaction utility. Acquisition utility
depends on the value of the good received compared to the outlay whereas transaction utility
depends on the perceived benefits of the “deal” at hand. Thus, total utility from a purchase is the
sum of the acquisition utility and the transaction utility. The author notes that the most important
determinant of the reference price (expected or “fair” price), which depends in large post on the
cost to the seller. The author then provides a model for the purchase decision process for when
there are multiple accounts.

Marketing Implications

The author provides some advice for sellers, based on the presumption that buyers behave
according to the theory: When a seller has a product with more than one dimension, it is
desirable to have each dimension evaluated separately. Sellers have a distinct advantage in
selling something if its cost can be added onto another larger purchase (i.e. addition of options
to a house or car purchase). Underpricing only occurs when two conditions are present: the
market-clearing price is much higher than a well-established reference price, and there is much
an ongoing monetary relationship between the buyer and seller. Sellers who have a monopoly
over some popular product may find themselves charging prices less than the market-clearing
price. The theory provides three strategies they can use: increase the perceived reference price,
increase the minimum purchase required and/or to tie the sale of the product to something else,
or obscure the reference price to make the transaction disutility less salient.