nep-exp New Economics Papers
on Experimental Economics
Issue of 2007‒08‒18
two papers chosen by
Daniel Houser
George Mason University

  1. Ordinal vs Cardinal Status: Two Experiments By Ennio Bilancini; Leonardo Boncinelli
  2. The effect of relative thinking on firm strategy and market outcomes: A location differentiation model with endogenous transportation costs By Azar, Ofer H.

  1. By: Ennio Bilancini; Leonardo Boncinelli
    Abstract: We demonstrate that in models where agents have concerns for status the model predictions can drastically change depending on whether status is modelled as an ordinal or cardinal magnitude. As a proof, we show that two well known theoretical findings are not robust to the substitution of ordinal status with cardinal status (Frank (1985)) and viceversa (Clark and Oswald (1998)).
    Keywords: Status, Social Comparison, Ordinality, Cardinality
    JEL: D0
    Date: 2007–08
  2. By: Azar, Ofer H.
    Abstract: Consumers often have to decide whether to go to a remote store for a lower price. Only the absolute price difference between the stores should be relevant in this case, but several experiments showed that people exhibit "relative thinking": they are affected also by the relative savings (relative to the good's price). This article analyzes the effects of this bias on firm strategy and market outcomes using a two-period game-theoretic model of location differentiation. Relative thinking causes consumers to make less effort to save a constant amount when they buy more expensive goods. In the location differentiation context this behavior can be modeled by consumers who behave as if their transportation costs are an increasing function of the good's price. This gives firms an additional incentive to raise prices, in order to increase the perceived transportation costs of consumers, which consequently softens competition and allows higher profits. Therefore, the response of firms to relative thinking raises prices and profits and reduces consumer surplus, in both periods. Total welfare is unchanged in the first period, and in the second period it is either unchanged or reduced, depending on whether the objective or subjective transportation costs are used to compute welfare. The main results of the model (firms' response to relative thinking increases prices and reduces consumer surplus) are likely to hold also in the context of search. The article also explains why "relative thinking" is a more appropriate term than "mental accounting" (which was often used before) to describe this behavior, and discusses why people might exhibit relative thinking.
    Keywords: Competitive Strategy; Relative Thinking; Pricing; Mental Accounting; Consumer Psychology; Consumer Attitudes & Behavior; Cognitive Processes; Behavioral Decision Making; Industrial Organization; Product Differentiation.
    JEL: D10 M31 L10 L13 D43
    Date: 2007

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