Question

Conlin, O’Donoghue and Vogelsang (2007) looked at catalog orders from an apparel and gear company that sells weather-related items. They found that if the temperature on the date a cold weather is purchased is 30 degrees F lower, the probability of returning the item increases by 3.95%. They view this as evidence in support of projection bias. Why?

3) Consider buyers’ demand for durable goods. How might projection bias and the endowment effect impact the price they are willing to pay?

Answer 1

2). The findings of Conlin, O’Donoghue, and Vogelsang (2007) are seen as evidence in support of projection because the increased probability of returns indicates that the buyers had overestimated the utility of their purchase. Winter Apparel or winter gear bought on an exceptionally cold day is driven by the prevailing cold conditions at that particular point in the present. Given the projection bias, however, the buyer usually tends to believe that s/he will derive the same or more utility in the future as well from the purchase of that winter wear. However, since the purchase was made on an unusually cold day (like when the temperature was 30 degrees lower) and it's uncertain that such weather conditions would reappear, the probability of returning that winter wear goes up.

3). Let's consider two durable goods that are commonly purchased- vehicles and houses. When a consumer purchases one of these durable goods, s/he decides on the price one is willing to pay for such a good based on certain parameters. Given that it is a durable good, the consumer at the time of purchase tries to predict how much utility s/he will derive from the consumption of the good in the future.

Projection bias is a kind of cognitive bias in which one tends to believe that one will think, feel, and act the same in the future as we do now. This is to say that one overestimates the prevalence of present value judgment to the future periods as well. Endowment effect, on the other hand, suggests that one tends to overvalue the possession of goods owned by self in the future despite the actual market value that prevails at that time in the future.

It is usually the case that consumers overvalue the utility they shall drive from the purchase of durable goods, like house or car, and thus, are willing to pay a higher price for it.

Given that a consumer needs a durable good in current period 't', s/he values that durable good highly. While making the purchase of a car/house in current period 't', projection bias suggests that consumers may mistakenly purchase the car/house that has a high utility at the time of purchase, but whose utility will not be as high in future when the consumer will own that vehicle or house. Thus, s/he will be willing to pay a higher price keeping the higher valuation in the future in mind.

Similarly, due to the endowment effect, one believes that the car/house owned in time period 't' will be worth a lot more in some future time period 't+n'. Thus, they are willing to pay a higher price in period 't' for that durable car.

There is a lot of literature that suggests that how people mistakenly buy overpriced durable goods because they tend to overvalue the utility they shall derive from the purchase and eventually the purchase of the good.