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Lecture 39 Policy Implications of Mental Accounting

  • Assumed that institutions respond rationally to non-NM behavior of individuals
  • Firms are rich in xp and have competition (else driven out of market). Firms have their own biases (principal-agent problem), yet they have incentives to respond to non-NM behavior of consumers

Responses of 5 main categories:

1. Individual Agents

  • Expense allocation categories should be unambiguous
  • More likely to spend if ambiguous (self-control device, enveloped cash for specific uses)

  • \(\implies\) Gift giving (good gift is outside their budget for that category of expenditure)

  • Self control device (ATM withdrawal restrictions)

    • If no future opportunities to withdraw, consumers limit purchases to small amounts
  • Pre-payment increases commitment and also increases motivation and engagement
  • TIME BUDGETING policy implications: Author, 5 pages per day

2. Marketers

  1. Sales Promotion
    • Extra product promotion: 50% extra
      • Doesn't segregate gains
    • Price off promotion: 50% off
      • Segregates gains
    • Premium promotion: Get a soap free
      • Segregates gains
    • So "segregate gains" methods more effective, support hedonic editing hypothesis
    • No discount rate > low discount rate
      • No discount rate = ref = regular price
      • But low 5% discount rate will be compared to a higher discount (as ref) \(\to\) Buy elsewhere, or wait expecting larger discount in the future \(\implies\) Lower transaction utility than "No discount"
    • Multiple discounts are more effective (than a singular amounting to the same)
      • one reason: segregation of gains
      • other reasons: 20% off + 25% off = 40% off
        • 'face value' effect (wrongly perceive first one as 45%)
      • another: maybe its a rare offer
        • pay more for products which is considered scarce
        • Limited period/amount offer tends to increase sales
    • Emotional appeal
      • 50% discount on two snacks that costs the same causes a switch in preference to the one with more emotional appeal and the cognitive appeal.

  2. Free offers

    • Conflicting evidence to freebies' effectiveness
    • This kind of offer decreases the price consumers are willing to pay (low quality and the focal product too)1
      • so long-term damaging effect on overall sales
    • But may not think so, as they will use the price of the focal purchase to make the evaluation of the quality of the freebie.

  3. Bundling

    • two or more products sold as a single package
    • Two pricing strategies
      • consolidated pricing
        • MA principle of aggregating losses but,
        • there is evidence: consumer can pay 92 + 5 (shipping) but not 97
      • partitioned pricing
        • may segregate losses, reducing consumers evaluations…
        • but prices can be viewed as a proxy of benefit (K&T) and thus, can improve evaluations by segregating these gains…
    • Salience: consumption-related accessory has greater salience than performance-related accessory
  4. Disaggregated pricing
    • Express in amount per day: $500 per year health club membership = 1.37 per day
  5. Pricing structure
    • Firms take advantage of Overconfidence (non-NM feature)
    • People are overconfident of their demand forecasts (underestimate the usage of recreational goods)
    • So offer:
      • tariff at zero marginal cost (free mintues)
        • steep marginal charges
  6. Cash vs Credit cards
    • Credit card is preferred because
      • salience
      • payment decoupling
      • greater feeling of loss when paying by cash
    • Post-transaction connection is greater when payment is made by cash… emotional attachment to the product. Brand loyalty \(\implies\) repeat purchase. Greater commitment to seller
    • Disposition effect: "Was the cash purchase, a mistake?" "NO!"
      • Company relying on credit card purchases initially make more sales
      • …on more fickle customers
  7. Trade-in pricing
    • More value to a good being traded than purchased (a used car being exchanged…)
    • So, car dealers
      • artificially inflate price of car being purchased
      • artificially inflate the trade-in allowance
    • Advice:
      • keep the two transactions separate

*[NM]: Neoclassical Model

  1. Focal product/purchase refers to the main product being sold. Alongside which the freebie is being provided. ↩