1. Status quo gains and losses are essentially measured against the change in the status quo.
2. We know about diminishing marginal utility with goods but theres also diminishing marginal disutility with losses where theres a much greater decrease in marginal utility with the first loss.
3. People are loss averse and will feel losses to a greater magnitude than gains of an equal amount.
1. Losses and Shrinking Packages.
a. When making purchases, consumers tend to focus only on price when determining their gains and losses.b. Therefore to makeup for increased costs, Hersheys decreased the size of their chocolate bar in order to avoid an increase in price.
c. The important point is that consumers dont view this as a loss because they focus on price and price didnt change (no observable change in status quo).
2. Framing Effects and Advertising
a. Evaluation of gains and losses largely depends on a persons mental frame and when new information is introduced to change a persons frame their gains/losses are called framing effects.b. For example, making $100,000 may be appealing to someone until they find out they had been earning $140,000.
c. Another example of framing is in advertising. Often hamburger producers label hamburger as 80% lean not 20% fat because 80% lean is framed as a gain.
3. Anchoring and Credit Card Bills
a. Peoples value of an item is influenced by irrelevant information which is called anchoring.b. Example: Students asked to write down the last 2 digits of their social security numbers are then asked to write down the value of a good like a wireless keyboard. Those with lower ending social security numbers were likely to provide lower estimates while those with higher ending numbers provided higher estimates.
c. Credit card companies use anchoring by requiring very low monthly payments thereby inducing consumers to make smaller payments and increasing the total amount paid on the debt.
4. Mental accounting and over priced warranties
a. Sometimes consumers dont view all of their consumption options simultaneously as predicted by the utility-maximization rule. Richard Thaler called it mental accounting when consumers looked at some purchases as isolated transactions.
b. When making big-item purchases like a $1,000 TV, the buyer is offered a warranty. The buyer often looks at this transaction in isolation, viewing this as a potential $1,000 loss if the TV breaks. The buyer is usually enticed to buy the warranty even though theres a small possibility of it breaking because the consumer doesnt consider their future income.
5. The endowment effect and market transactions
a. There is a tendency for people to have a higher value of an item if they own it, called the endowment effect.b. For example, a coffee mug that I dont own is worth $10 to me, but once the mug is mine the value of the mug increases to $15. As a result of strong endowment effects, transactions between buyers and sellers are difficult.
c. The endowment effect is in part due to people being loss averse where parting with an item they own is viewed as a loss and people tend to feel potential losses 2.5 times more than potential gains.
6. Consider ThisRising consumption and the Hedonic Treadmill
a. Hedonic treadmill is the idea that people get used to a certain level of consumption and when consumption increases they are happier for awhile, but then they get used to it and they arent any happier than they were at lower consumption levels.
b. for example:
- people with different incomes report similar levels of satisfaction
- if you start saving for retirement you will initially notice the loss in consumption, but you will get used to it and your overall level of satisfaction will remain the same