A Rational Model to Predict Consumers’ Irrational Behavior

The current research developed a mathematical model that could predict consumers’ price-quality perceptions based on their ability and motivation to process the product information accurately. This model effectively demonstrates how the price can influence consumers’ judgments of quality after they purchased and used the product. Furthermore, this model sheds light on the underlying reasons that price has different effects on consumers’ perceptions of quality under different product categories. Finally, this model offers a powerful statistical tool that could be utilized to find the best price-points for products in dynamic environments. The developed model is based on the reference-dependent utility model proposed by Kőszegi and Rabin (2006). They argued that expected utility is the sum of gain/loss utility [n (q|r), consistent with the predictions of prospect theory (Kahneman and Tversky 1979)], and reference-dependent consumption utility [m (q|r)], where m(q) denotes the experience of quality and m(r) denotes the expectation of quality: (1) U(q|r) = m (q|r) + n (q|r) In this model, when m(q) – m(r) > 0, consumers will experience a gain utility equal to ƞ[m(q|r) – m(r)]. In contrast, when m(q) – m(r) < 0, consumers will experience a loss utility of ƞλ[m(q|r) – m(r)]. λ is always greater than one because as proposed by Kahneman and Tversky (1979) losses have a greater influence on consumers’ experienced utility (a strong negative effect) than gains. Furthermore, Kőszegi and Rabin (2006) argued that the consumption utility itself would depend on a reference point. As an example, driving a C-Class Mercedes-Benz would create a higher consumption utility when the reference product of the driver is a Toyota Camry than when it is a Rolls-Royce. This notion is consistent with the placebo effect of the price that is reported in the literature (Shiv, Carmon, and Ariely 2005).