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Do consumers make too much effort to save on cheap items and too little to save on expensive items? experimental results and implications for business strategy

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  • Azar, Ofer H.

Abstract

The article presents an experiment that illustrates a behavior that I denote “relative thinking.” Subjects in the experiment revealed the minimal price difference for which they were willing to spend 20 minutes and go to a cheaper store. Five different goods and nine different prices were used in a between-subjects design. Subjects showed striking positive correlation between the good’s price and their valuation of their time as it was reflected in their decisions. The experiment suggests that subjects think about both the relative and the absolute price differences, even though according to economic theory they should only consider the absolute price difference. Quantifying the effect suggests that consumers’ valuation of their time is approximately proportional to the square root of the price of the good they want to purchase. Studying economics courses seems to mitigate relative thinking. Several alternative explanations for the observed behavior are suggested and discussed, but the conclusion is that only the relative thinking explanation can account for the experimental results. Finally, several implications of relative thinking for business strategy are discussed.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 20962.

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Date of creation: 2009
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Handle: RePEc:pra:mprapa:20962

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Keywords: Relative thinking; Consumer behavior; Behavioral economics;

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  1. Ofer H. Azar, 2013. "Firm strategy and biased decision making: the price dispersion puzzle," Applied Economics, Taylor & Francis Journals, Taylor & Francis Journals, vol. 45(7), pages 901-910, March.
  2. Ofer H. Azar, 2011. "Does Relative Thinking Exist In Real‐World Situations? A Field Experiment With Bagels And Cream Cheese," Economic Inquiry, Western Economic Association International, Western Economic Association International, vol. 49(2), pages 564-572, 04.
  3. Pratt, John W & Wise, David A & Zeckhauser, Richard, 1979. "Price Differences in Almost Competitive Markets," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 93(2), pages 189-211, May.
  4. Azar, Ofer H., 2008. "The effect of relative thinking on firm strategy and market outcomes: A location differentiation model with endogenous transportation costs," Journal of Economic Psychology, Elsevier, Elsevier, vol. 29(5), pages 684-697, November.
  5. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  6. Richard Thaler, 1985. "Mental Accounting and Consumer Choice," Marketing Science, INFORMS, INFORMS, vol. 4(3), pages 199-214.
  7. Tversky, Amos & Kahneman, Daniel, 1991. "Loss Aversion in Riskless Choice: A Reference-Dependent Model," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 106(4), pages 1039-61, November.
  8. Heath, Timothy B & Chatterjee, Subimal & France, Karen Russo, 1995. " Mental Accounting and Changes in Price: The Frame Dependence of Reference Dependence," Journal of Consumer Research, University of Chicago Press, University of Chicago Press, vol. 22(1), pages 90-97, June.
  9. Ofer H. Azar, 2005. "Relative Thinking Theory," Microeconomics, EconWPA 0504002, EconWPA.
  10. Alan T. Sorensen, 2000. "Equilibrium Price Dispersion in Retail Markets for Prescription Drugs," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 108(4), pages 833-862, August.
  11. Camerer, Colin F. & Hogarth, Robin M., 1999. "The Effects of Financial Incentives in Experiments: A Review and Capital-Labor-Production Framework," Working Papers, California Institute of Technology, Division of the Humanities and Social Sciences 1059, California Institute of Technology, Division of the Humanities and Social Sciences.
  12. Frisch, Deborah, 1993. "Reasons for Framing Effects," Organizational Behavior and Human Decision Processes, Elsevier, Elsevier, vol. 54(3), pages 399-429, April.
  13. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard, 1986. "Fairness as a Constraint on Profit Seeking: Entitlements in the Market," American Economic Review, American Economic Association, American Economic Association, vol. 76(4), pages 728-41, September.
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Cited by:
  1. Azar, Ofer H., 2007. "Relative thinking theory," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, Elsevier, vol. 36(1), pages 1-14, February.

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