ABSTRACT
This chapter reviews developments in behavioural economics with an emphasis on pricing implications. Behavioural economics was a reaction against the fundamental assumptions of traditional economics, that customers and firms were perfectly informed, utility and profit maximisers. Economists knew the assumptions were unrealistic but argued they were “good enough” and led to tractable theory and good predictions.
Led by Kahneman, Tversky and Thaler in the late twentieth century behavioural economists showed that consumers made predictably “irrational” decisions. They tend to overestimate or underestimate probabilities, value early payoffs much more than later ones, continue to place value on sunk costs, undervalue opportunity costs, be overly influenced by an “anchor”, overvalue something they already own and suffer “extreme aversion”, tending to choose the central option from a range of three,
Many of these “misbehavours” have pricing implications and underpin practices such as good-better-best pricing; including an expensive option or “decoy” in a product range and preferring to offer a “discount” on a higher price rather than a surcharge on a lower one.
