Behavior economics is a relatively new concept that was developed by Daniel Kahneman and Amos Tversky and is known as the prospect theory. The prospect theory posits that consumers are inspired by the comparison of prices to the reference price rather than the actual price. Please discuss why managing price expectations is as important as managing price. Please give three examples of local restaurants using prospect theory. Include a minimum of one reference.
Sample Solution
- People are more sensitive to changes in prices relative to their expectations than to changes in absolute prices. This means that a small change in price can have a big impact on demand if it is unexpected. For example, if a restaurant's regular price for a meal is $10, and they offer a special for $5, people are more likely to be attracted to the special because it is a significant discount from their expectations.
- People are more likely to make a purchase if they perceive it as a bargain. This is because people feel good about getting a good deal, and they are more likely to remember and recommend a business that offers good deals. For example, a restaurant that offers a "2 for 1" special is more likely to attract customers than a restaurant that simply offers a 10% discount on all meals.
- People are more likely to be satisfied with a purchase if they perceive it as a good value. This is because people's satisfaction with a purchase is often based on their expectations. For example, if a customer expects to pay $10 for a meal, and they only pay $5, they are more likely to be satisfied with the meal, even if it is not the best meal they have ever had.
Here are three examples of local restaurants using prospect theory:
- A restaurant that offers a "happy hour" with discounted drinks and appetizers. This is a good example of how a restaurant can use prospect theory to attract customers. The discounted prices are a significant departure from the restaurant's regular prices, so people are more likely to be attracted to the happy hour.
- A restaurant that offers a "buy one, get one free" special on certain items. This is another good example of how a restaurant can use prospect theory to attract customers. The "buy one, get one free" special creates the perception of a bargain, which is more likely to attract customers.
- A restaurant that offers a "loyalty program" that gives customers discounts or free items for their continued patronage. This is a good example of how a restaurant can use prospect theory to build customer loyalty. The discounts and free items create the perception of a good value, which is more likely to keep customers coming back.
[Reference] Prospect Theory: An Overview by Daniel Kahneman and Amos Tversky (1979)