Do Consumers Make Too Much Effort to Save on Cheap Items and Too Little to Save on Expensive Items? Experimental Results and Implications for Business Strategy

Abstract

The article presents an experiment that illustrates a behavior that I denote “relative thinking.” Subjects in the experiment revealed the minimal price difference for which they were willing to spend 20 minutes and go to a cheaper store. Five different goods and nine different prices were used in a between-subjects design. Subjects showed striking positive correlation between the good’s price and their valuation of their time as it was reflected in their decisions. The experiment suggests that subjects think about both the relative and the absolute price differences, even though according to economic theory they should only consider the absolute price difference. Quantifying the effect suggests that consumers’ valuation of their time is approximately proportional to the square root of the price of the good they want to purchase. Studying economics courses seems to mitigate relative thinking. Several alternative explanations for the observed behavior are suggested and discussed, but the conclusion is that only the relative thinking explanation can account for the experimental results. Finally, several implications of relative thinking for business strategy are discussed.

Keywords: Relative thinking, Consumer behavior, Behavioral economics

JEL Classification: C91, D03, D10, M10, M30