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customers with something called “everyday low pricing,” but these experiments usually fail.‡ Getting a great deal is more fun than saving a small and largely invisible amount on each item.
might well be true that consumers were not paying any more under the new regime, but they were missing out on lots of transaction utility. They even lost that tiny pleasure of paying just “under” a given dollar amount, e.g., $9.99 rather than $10. The experiment was a flop. JC Penney’s sales and stock price plummeted as the changes took effect in 2012. A year later, Johnson was ousted and coupons returned to JC Penney customers.
Walmart also offers a variation on the old ploy of guaranteeing that they have the lowest prices available by allowing shoppers to scan their receipts into a “savings catcher” app that promises to give a refund to anyone if there is a lower price available.
A recent study finds that when U.S. supermarkets were confronted with the challenge of a Walmart entering their home market, all suffered, but those who used a promotional pricing strategy (e.g., frequent sales) experienced significantly greater revenues and long-term viability than an everyday low price strategy (Ellickson, Misra, and Nair, 2012).
Vince paid $1,000 to an indoor tennis club that entitled him to play once a week for the indoor season. After two months he developed tennis elbow, which made playing painful. He continued to play in pain for three more months because he did not want to waste the membership fee.
When an amount of money has been spent and the money cannot be retrieved, the money is said to be sunk, meaning gone. Expressions such as “don’t cry over spilt milk”
Here is a thought experiment. You buy a pair of shoes, perhaps because they were on sale and, while still expensive, you could not pass up all that transaction utility. You proudly wear them to work one day and by noon your feet hurt. After letting your feet heal, you try the shoes again, just for an evening this time, but they still hurt. Two questions: Assuming that the shoes never get comfortable, how many more times will you try to wear these shoes before you give up? And, after you have stopped wearing them, how long will they sit in the back of your closet before you toss them or donate
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This club bills its members twice a year. Gourville and Soman found that attendance at the club jumps the month after the bill arrives, then tails off over time until the next bill arrives. They called this phenomenon “payment depreciation,” meaning that the effects of sunk costs wear off over time.
Those who paid full price went to more events in the fall semester, but by the spring attendance was the same across the three groups; apparently the students had gone to enough plays to feel they had gotten their money’s worth, or had just forgotten the original purchase altogether.
So sunk costs matter, at least for a while, but may be forgotten eventually.
Eldar and I published a paper on this, with a title that fully summarizes the findings: “Invest Now, Drink Later, Spend Never.”
The bigger lesson is that once you understand a behavioral problem, you can sometimes invent a behavioral solution to it.
This can lead to the odd behavior of simultaneously borrowing at a high rate of interest and saving at a low rate, for example by keeping money in a savings account earning virtually no interest while maintaining an outstanding balance on a credit card that charges interest at more than 20% per year.
Even though such cash-outs are taxable income and are subject to a 10% surcharge, many employees take the money,
In the past three decades, interest rates in the United States have declined from double digits to essentially zero (or less, if you adjust for inflation).
In 1989 only 5.8% of such families had any mortgage debt. By 2010, the fraction with debt rose to 21.2%. For those with mortgage debt, the median amount owed also rose over this period, from $35,000 to $82,000 (in 2010 dollars).
As documented in House of Debt, a book by economists Atif Mian and Amir Sufi, by 2000 increases in home equity had become a strong driver of consumption, especially of consumer durables. For example, in cities where house prices were booming, automobile sales also jumped, as homeowners borrowed against the increased equity in their home and used the proceeds to finance a new car.
This phenomenon helps explain why the burst of the tech bubble in 2000–01 did not cause the same deep recession as the pricking of the housing bubble. Most non-wealthy households only hold stocks in their retirement accounts, which are still relatively sticky places to keep their money, especially for those with non-trivial account balances.
This means that the fall in stock prices did not impact spending as much as the fall in home prices.
Like most aspects of mental accounting, setting up non-fungible budgets is not entirely silly. Be it with mason jars, envelopes, or sophisticated financial apps, a household that makes a serious effort to create a financial plan will have an easier time living within its means.
Kahneman and Tversky explained this finding by relying on the feature of prospect theory that people are risk-seeking when it concerns losses. As was discussed in chapter 4, if you ask people whether they would rather lose $100 for sure or choose a gamble in which they have a 50% chance of losing $200 and a 50% chance of breaking even, a majority will choose the gamble.
During the 1990s, individual investors were steadily increasing the proportion of their retirement fund contributions to stocks over bonds, meaning that the portion of their new investments that was allocated to stocks was rising. Part of the reasoning seemed to be that they had made so much money in recent years that even if the market fell, they would only lose those newer gains. Of course, the fact that some of your money has been made recently should not diminish the sense of loss if that money goes up in smoke. The same thinking pervaded the views of speculative investors in the boom
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A good rule to remember is that people who are threatened with big losses and have a chance to break even will be unusually willing to take risks, even if they are normally quite risk averse.
Prospect theory
Smokers paid more for their cigarettes by purchasing them one pack at a time instead of by the carton. Dieters did not stock any ice cream in the freezer. Academics (including me) would commit themselves to present a paper that was still a work in progress at a conference several months off, to give themselves an incentive to finish it. People who had trouble getting up in the morning put their alarm clocks on the other side of the room so they could not just reach over and switch off the alarm without getting out of bed.
“Our telescopic faculty is defective and . . . we, therefore, see future pleasures, as it were, on a diminished scale.”
Paul Samuelson, then in graduate school, to finish the job. Samuelson, whom many consider to be the greatest economist of the twentieth century,
Samuelson formulation, we are said to “discount” future consumption at some rate. If a dinner a year from now is only considered to be 90% as good as one right now, we are said to be discounting the future dinner at an annual rate of about 10%.
Samuelson correctly notes that if people discount the future at rates that vary over time, then people may not behave consistently, that is, they may change their minds as time moves forward. The specific case he worries about is the same one that worried earlier economists such as Jevons and Pigou, namely, the case where we are most impatient for immediate rewards.
we could encourage retirement payment via showing them what they lost for not increasing the payment
present-biased
discount the future
Intertemporal choice
Notice that as we go from Keynes to Friedman to Modigliani, the economic agents are thinking further ahead and are implicitly assumed to be able to exert enough willpower to delay consumption,
If we judge a model by the accuracy of its predictions, as advocated by Friedman, then in my judgment the winner among the three models’ ability to explain what people do with temporary changes to their income would be Keynes, modified somewhat in Friedman’s direction to incorporate the natural tendency to smooth out short-run fluctuations.
If the $1,000 windfall had come from a lucky night at the casino, Barro would make the same prediction as Modigliani about consumption. But if the windfall is a temporary tax cut that is financed by issuing government bonds, then Barro’s prediction changes. The bonds will have to be repaid eventually. The beneficiary of the tax cut understands all this, and realizes that his heir’s taxes will eventually have to go up to pay for the tax cut he is receiving, so he won’t spend any of it.
