Lecture 12 Types of Utility

Kahneman (2000):
- remembered utility after the experience
- real-time utility during the experience
Remembered Utility
- memory-based approach (evaluation of past experience)
- Subject to bias: application of Peak-End rule¹A
- Colonoscopy studies: Redelmeier and Kahneman (1996)
  - Prolongation of the duration of the pain at lower levels lead to better evaluation
- People base decisions based on remembered past utility or disutility
- Retrospective hedonic editing: Cowley (2008). Can result in justification of past indulgences, leading to continuation of self-harming behavior (gambling, over-eating)
Real-Time Utility
- Moment-based approach (more difficult to implement $\Leftarrow$ requires continuous monitoring, e.g. subjects were asked to rate their pain on a scale of 0 to 10 (intolerable pain) every 60 seconds)
- Can be used to derive (Kahneman's) total utility, which can be used as a measure of objective happiness²
Experienced Utility
- Distinction between wanting and liking
- Wanting: motivation aspects of reward
- Liking: hedonic aspects of reward
  - e.g. We may want not to like something... like smoking #doubt
- Neuroeconomic evidence for this distinction:
  - Dopamine is associated with motivation aspects of reward (wanting)
  - Disruption of dopamine doesn't impair the hedonic aspects (liking)
Endowment & Contrast effect (E&C) ^1bef7f
- Happiness $\neq$ well-being (people judge levels of these two, based on E&C effects)
- We are not referring to endowment effect as "acquisition of goods causing the acquirer to value the goods more highly than expected"
  - Tversky & Griffin: Endowment effect of an event is its direct contribution one's happiness/satisfaction.
  - Good news/experiences enrich our lives and make us happier.
  - Bad news/hard times diminish our well-being
- The Contrast Effect: indirect effect that works in the opposite direction
  - Positive experience $\to$ happy but renders similar experiences less exciting. e.g. Winning music competition for the first time, vs second time.
  - Negative experience $\to$ unhappy, but helps us asses similar subsequent exp as less bad.
Treadmill Effect: psychological adaption to pain and pleasure over time
- Existence supported by two theories:
  1. Adaptation theory: In terms of adaptation, hedonic response
    - Experiment
      - One hand in hot water, other in cold water for a period of time
      - Then, both hands in the same container of lukewarm water
      - One hand feels warm (prev in cold), the other feels cold (prev in hot)
    - This theory explains, how lottery winners and paraplegics adjust rapidly to changed circumstances
    - Not everyone convinced...
  2. Kahneman proposed a different mechanism: using the term satisfaction treadmill. Explained in terms of the aspiration effect.
    - Grad student constrained by her income to eat mediocre dishes in restaurants
    - After a lucrative job switch, she can afford higher quality food. But on consuming the same food as before her utility won't be as much as before...
    - This is because her aspiration level has increased.
    - At high aspiration level, ceteris paribus, the utility from the same bundle is lowered.
    - Another way of putting things: There is no longer a contrast** between the food she was consuming before and after the income increase.
  3. ECT applications
    - Experiment (spend an hour): some subjects placed in extremely pleasant (decorated, well-furnished) and others in extremely unpleasant (small, dirty, noisy, overheated)
    - Pleasant room: higher overall life satisfaction than unpleasant room ones $\implies$ Dominance of the endowment effect.
    - Unpleasant room: higher satisfaction with their own housing (like back home after the experiment) than pleasant room ones $\implies$ Dominance of contrast effect
    - Tversky & Griffin (2000) concluded: > A specific event is likely to have a significant contrast effect in the domain to which it (the event) belongs. An little to no contrast effect in others.
Anticipatory Utility
- People gain hedonic utility from their anticipation of events. "Looking forward to that Jacob Collier Concert"
- ...based on a person's expected or predicted utility (belief about future experienced utility)
- "Playing a lottery" cannot be explained by EUT, but ECT can
  - Unrealized hopes and fear $\implies$ +ve or -ve endowment in terms of anticipatory utility.
  - $P(\text{Winning Lottery})$ is very low. So failure doesn't cause much disappointment
  - Tversky & Griffin (2000): "Dream of becoming an overnight millionaire" pleasure $\gt\gt$ mild disappointment of not winning the lottery.
  - $\text{+ve Endowment Effect} \gt \text{-ve Contrast effect}$ $\implies$ People can continue to play lottery even if they don't win.
  - Evidence (study by Kocher, Krawczyk and van Winden (2014)): Lottery playing subjects preferred to wait longer for the result
    - Also preferred playing two tickets in separate draw (than in the same draw), thus prolonging period of anticipation.
    - Contrast effect is highly sensitive to probability of winning/losing
    - As $P(\text{Winning}) \uparrow$ . $D \uparrow$ faster than $B\uparrow$
      - $D:$ Disappointment of losing (contrast effect)
      - $B:$ Benefits from the hope of winning.
      - People prefer long-odds over short-odds
        
        Sweeter dreams and milder disappointments.
Residual Utility
- Pleasure or pain felt at later periods of time in separate episodes
- Enjoy holiday for a month (anticipation and the actual event) and then suffer a contrast effect when they return to work.
- Later episode: Maybe a month later they feel another utility boost related to the same holiday exp, when reminiscing with friends.
  - Such episodes may be repeated at various intervals
- Residual Utility arises from reminiscence.
- Can also be negative: dwelling on a bad experience.
Diagnostic Utility (DU)
- People infer utility from their actions.
- Alcohol consumption decision: consider the experienced or hedonic utility... Also, utility inferred from the action of consumption $\implies$ vice of a weak will or signal of a strong will. (also jogging more rounds)³
  - Possible that $\text{-ve DU} \gt \text{+ve }E[\text{EU}]$ $\implies$ abstain from consumption
  - Process of self-signalling**: Particularly important for people who are uncertain about their attribute (i.e. "Do I really have a strong willpower?")
- $\implies$ Temptation shouldn't be seen as a cost... there's a benefit too.
  - A Dieting Person
    - experienced disutility = hunger
    - benefit of +ve DU = improved self esteem if they refrain
      - They don't get this however, if they have had a gastric band surgery in which case they don't feel hungry.
Transaction Utility
- NM says: Net value = $\text{Benefit} - \text{Cost}$
- Reality: loss-aversion phenomena makes this coding, hedonically inefficient
- $\implies$ Kahneman & Tversky (1984) reject "costs = losses"
- Thaler proposes two types of utility gained from a transaction:
  1. Acquisition Utility: $\sim$ Consumer Surplus, value relative to price (of a good)
  2. Transaction Utility: Perceived value of the deal or $\text{Reference Price} - \text{Paid Price}$ (RP - PP)
    - RP may be the price that consumer expects to pay for the good
- $\implies$ People are tempted to buy deals where TU > AcqU
  - Marketing strategies: manipulate framing of offers... Reference Prices and emphasize on savings. - e.g. "~~₹4000~~ ₹2000 only! Limited Time offer!"
- $\implies$ Forgo goods that benefit in terms of AcqU but get rejected due to higher perceived transaction disutility.
- Additional Dimension: notion of fairness
- Competitive consumers gain utility if they think that they outsmarted the market.
  - e.g. "Deal is better if the offer is more valuable than the marketer intended"
    - M1 (to M2, who is far away): How much does this car cost?
    - M2: $3000.
    - M1: What... you said $2000?
    - M2: Yeah, wait... I am getting a call.
    - C: (knows that M1 has misheard and thinks it will be a great deal) Can I buy this immediately?
    - M1: Yeah, sure! Let's go inside and get the paperwork done.
    - C: No, I don't need all that... take this cash... (Gives him $2000.)
    - M1: Okay! Here are the keys...
    - (C drives away thinking he scammed them)
    - Later that evening,
      - M1: Haha... He actually thought I couldn't hear properly... we sold it to him at $2000. Nobody was buying it before. Good move.
      - M2: Yeah, I know. But I don't think this strategy will work every time.
      - M1: It will... Because TU > AU.
- Important counter-intuitive policy implications for marketers in terms of targeted promotions #doubt

Peak-End rule, we happen to remember something (from a certain experience)... we remember the experience something at the peak, and something at the end of the experience. ↩
Under certain assumptions ↩
If I am able to resist myself, I will get a signal of having a strong will and I will get a satisfaction out of that... ↩