Question

7. Behavioral economists have coined the term “loss aversion” as part of “prospect theory” and it suggests that for most people, “losses loom larger than gains.” Recall our illustration in class where people seemed to be more willing to take risks to avoid losses but play it more conservatively when achieving a similarly sized gain. In their experiments, they demonstrated loss aversion by simulating how much money a student would be willing to pay for a coffee mug that they do not yet own as compared to how much they would be required to be paid to part with a coffee mug that they already owned. In the experiments, the latter values seemed to trump the former.

But is this a generalizable result? Are there cases where this does not happen? Think about cash. If you have a $5 bill in your hand, how much money would you require from someone in order to part with the $5 bill? Similarly, if you do not have a $5 bill, how much money would you be willing to pay to get it back? My supposition is that in each case, your WTA and WTP are the same, and that is $5. So, in the case of money, we do not demonstrate loss aversion. Why do you think this is different than the case of coffee mugs?

Answer 1

Classical pricing research and methodology are all built on the assumption that people think and decide rationally. It is simply impossible within this approach to leverage the margin potentials given by the predictably irrational behavior real people show. Behavioral Pricing has empirically proven that people have a predefined “willingness to pay”. This is completely wrong. Rather than having a pre determined willingness to pay, people tend to develop a price acceptance while they are in the decision making process.

Price acceptance is not driven by value as is assumed in value-based pricing. People are driven, as per the loss aversion theory, the want to cut their losses double as much.

This evaluation and reevaluation is only possible when there is room to determine a price for what you are exchanging. The freedom to think and decide comes in when the product in question has varying prices or values for different groups. For example, buyers, sellers and choosers when asked to price a product will have three varied prices.

But this is not the case when it comes to cash as there is already a pre determined value placed on that which is universal for all groups. A $10 bill has $10 written on it and with time that doesn’t change. But even though a price might be written on a product the value placed by different groups changes based on usage, sentimental value and of course to reduce losses.