Preferences and Price, or Price and Preferences?

Contemporary economics theories state that while preferences determine prices, they are independent from the price of goods.

In this post I will explain each study by using a concrete, day-to-day example. I hope these examples can help clarify why the price people pay for a good is not always a reliable indicator of how much they like it.

1 - The dissociation between monetary assessment and predicted utility¹
You have a reservation price (maximum willingness to pay) for a ticket to a concert. Knowing that the local producer is paying 2,500€ vs. 250,000€ to rent the concert space will not influence the pleasure you will get from the concert, but will certainly influence the price you are willing to pay for the ticket.

2 - In search of homo economicus: preference consistency, emotions, and cognition²

A bride is asked to choose a wedding dress from a selection of ten different dresses. In order to help her make a decision, the godfather asks her to choose one out two, from all the possible pairs of dresses (the mathematical term is pairwise comparisons and is calculated in the following way: (10*(10-1)/2. Which results in 45 comparisons). The godfather will get a better estimate of which is the bride's favorite dress (i.e., he will found greater preference consistency) if when asked to choose between the pairs, the bride compares the dresses through a spontaneous answer based on how beautiful they look, rather than if she compares them n terms of their brand name, popularity of the fashion designer, or cost.

3 – Money muddles thinking: the effect of price on preference consistency³

A cocktail bar wants to determine its customer’s favorite cocktails. In order to do that, it creates a tasting test where every customer has to choose one out of two, from all the possible pairwise comparisons of the possible cocktails. As with the bride example, the owner of will come to a better estimate of the favorite cocktails of his customers (i.e., greater preference consistency) when there is no information about the price of the cocktails than when there is.

4 – Price-sensitive preferences⁴

The price I am willing to pay for a hot dog is considerably higher in London than in Sarajevo. Nevertheless, hotdogs taste better in Sarajevo. Thus, although I prefer Sarajevo hotdogs, I am willing to pay more for London hotdogs. The prices I am willing to pay for a hotdog in London or Sarajevo do not reflect which hot dog I think is better. The prices are instead a biased expression of my preference due to the influence of the hotdogs price distribution in each city (considerably higher in London).

5 – Wealth, warmth, and well-being: whether happiness is relative or absolute depends on whether it is about money, acquisition, or consumption⁵

I decided to travel to the coast of Croatia for vacations. There are three types of satisfaction I will derive from doing so: (1) the satisfaction of having a budget to spend, (2) the satisfaction of buying the vacation, and (3) the satisfaction of consuming the vacation (i.e., being there). The satisfaction I get from the budget, and from buying the vacation is always relative (it depends on how big my budget is and how my salary ranks compared with others in society). The satisfaction I obtain from consuming the vacation can be either relative (e.g., how “good” my hotel is compared with the hotels of Croatia coast) or absolute (e.g., how pleasant the temperature of the water was).

References
1. Amir, O., Ariely, D. & Carmon, Z. (2008). The dissociation between monetary assessment
and predicted utility. Marketing Science, 27, 1055-1064.

2. Lee, L., Amir, O., & Ariely, D. (2009). In search of homo economics: preference consistency, emotions, and cognition. Journal of Consumer Research, 36, 173-187.

3. Lee, L., Bertini, M., & Ariely, D. (2008). Money muddles thinking: the effect of price on preference consistency. Working Paper.

4. Mazar, N., Koszegi, B., & Ariely, D. (2009). Price-sensitive preferences. Unpublished Manuscript.

5. Hsee, C. K., Yang, Y., Li, N. & Shen, L. (2009). Wealth, warmth and wellbeing: Whether
happiness is relative or absolute depends on whether it is about money, acquisition, or consumption. Journal of Marketing Research, 66, 396-409.