The Budget Contraction Effect: How Contracting Budgets Lead to Less Varied Choice

Citation: Kurt Carlson, Jared Wolfe, Simon blanchard, Joel Huber, Dan Arierly The Budget Contraction Effect: How Contracting Budgets Lead to Less Varied Choice.
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Summary

The authors propose that when consumers allocate initial budgets for several items, the amount allocated to each item becomes a reference point for future allocations. They also claim that consumers arriving at a given budget from a higher initial budget, will select fewer different types of items than those arriving at the same given budget from a lower initial budget. Through five experiments, the authors find evidence that this consumer behavior stems from a desires to avoid anticipated psychological loss associated with spreading the budget cuts broadly across many items.

The authors apply these findings to real life situations and provide recommendations. They state that, “during times of economic downturn, companies such as Amazon.com may prefer to emphasize albums by artists whose other songs consumers already own”; during economic downturns, consumers will allocate their budgets to fewer categories and with Amazon following these recommendations, it will be helping its customers keep their allocations narrow. In addition, the authors apply their findings to individual consumers, claiming that their findings can help consumers predict and correct their behaviors during budget contractions. For example, during economic downturns, individual investors tend to have a less-diversified portfolio. Realizing that this is caused by the budget contraction effect will allow these individuals to avoid these risky portfolios.