Mental Accounting and Consumer Choice

Citation: Richard Thaler (1985) Mental Accounting and Consumer Choice. Marketing Science (RSS)
Internet Archive Scholar (search for fulltext): Mental Accounting and Consumer Choice
Download: http://www.jstor.org.proxy.library.georgetown.edu/stable/40057241
Tagged: Consumer Behavior (RSS), Psychology (RSS), Marketing (RSS)

Summary

I. Introduction - This paper develops a new model of consumer behavior using a hybrid of cognitive psychology and principles of microeconomics. The author realizes that all organizations have explicit and/or implicit account systems, which often influence decisions in surprising ways. The goal of the author is to develop a richer theory of consumer behavior than standard economic theory. The author asserts that 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 with the exception of price and product characteristics.

II. Mental Arithmetic - The first step in describing the behavior of a consumer is to replace the utility function from economic theory with the value function, which is psychologically richer. The value function reflects the fact that people appear to respond more to perceived changes than to absolute levels, is assumed to be concave for gains and convex for losses, and 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: 1) segregate gains, b) integrate losses, c) cancel losses against larger gains, and d) 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.

III. Transaction 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.

Theoretical and Practical Relevance

IV. 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.