Lecture 33 Hedonic Framing, Acquisition Utility, and Transaction Utility

• Most people share the intuition that lead to the hedonic editing principles…
• Use hedonic framing in marketing context to improve the attractiveness of a product to consumers

Failure of Hedonic Editing

• Convenient of these principles could serve as a descriptive model of MA
• Formally, \(\&\) denotes cognitive combination of two outcomes
  • \(v(x\& y) = \max[v(x+y),v(x)+v(y)]\)
• Jacket and calculator problem. If $5 saving was coded in a utility maximizing way, it would be segregated… but data doesn't say so
• There must be some limits for us to engage in self-deception… Why stop at segregating the $5 gain? Why not code it as five gains of $1?
• Thaler & Johnson examined that it is preferred to temporally space two financial outcomes
  • If want to segregate, prefer them on different days (Temporal separation)
  • If want to integrate them… prefer them to occur together (Temporal proximity)
• Large majority thought temporal separation of gains would be preferred… but also that temporal separation of losses was also a good idea.
  • Intuition for hypothesis: loss function displays diminishing sensitivity… adding one loss on another should diminish the marginal impact
  • Subjects thought: prior loss makes them more sensitive to subsequent losses
    • Losses must be felt one by one… and bearing one loss makes one sensitive to then next

Summary, evidence suggests that rules of hedonic framing describe nicely, the way people would like to have the world organized. (small gains, silver linings, avoid loss but combine otherwise)

Reference Outcomes

• Expect \(x\), receive \(x+\Delta x\)
• Assume that the outcome was fully anticipated and assimilated \(v(x:x)=0\)
• If \(\Delta x \neq 0\), then what?
  • Diwali bonus of ₹10000
  • Error: Actual bonus ₹8000, return ₹2000
  • Friend expects the same bonus but received ₹8000
• For me, situation of loss of ₹2000
• For my friend, situation of reduction in gain by ₹2000, \(-[v(10000)-v(8000)]\)

This can be used to model a buyer's reaction to the market price that differs from price he expected.

Acquisition and Transaction Utility

• Consumer buy something
  • One possibility: code acquisition (as gain) and forgone money (as loss)
    • Loss aversion \(\implies\) Hedonically inefficient
• Feeling thirsty, willing to spend ₹40, but the bottle costs ₹30… better off.
• But we wouldn't make the purchase if we multiplied it by the coefficient of loss aversion \(2.25\) \(\implies\) Researchers believe that costs are not generally viewed as losses.

Thus, consumers get two kinds of utility from a purchase:

Acquisition Utility

Measure of the value of the good obtained relative to its price… consumer surplus.

\[ \text{Value consumer places on receiving} - \text{Price paid} \]

• Transaction utility = perceived value of the 'deal'

\[ \text{Amount paid} - \text{Reference Price} \]

• Reference = regular price expected to be paid for this product.

• Beer on the beach example:

  • Resort: $2.65
  • Store: $1.50
• For good \(z\),
  • \(p\) is the actual price of z (what consumer has to actually pay)
  • \(\bar{p}\) is the value equivalent of z (what consumer is willing to pay)
  • \(p^*\) is the reference price of z (what consumer expects to pay)
• Define #Acquisition Utility as
  • \((z,-p) = (\bar{p},-p)\)
  • Generally coded as the integrated outcome \(v(\bar{p}-p)\)
  • COGS is not treated as loss

Transaction Utility

• This utility depends on \(p\) (price of \(z\)) compared to \(p^*\) (reference)
• Defined formally as \(v(-p:-p^*)\)

Thus, the value of buying good \(z\) at price \(p\) with reference price \(p^*\) is defined as \(w(z,p,p^*)\)

\[ w(z,p,p^*) = v(\bar{p},-p) + v(-p:-p^*) \]

• Beach example
  • Reference price, \(p^*\) is higher for the resort
  • In a standard Econ model, place of purchase should be irrelevant.

Transaction utility explains the difference in the prices of the same product at different locations that consumer is willing to pay.

Effects in the marketplace

1. Some goods are purchased primarily because they are especially good deals.
2. We would miss out a pleasant drinking experience, just because the same beer was priced higher than he had expected in a store.