Principles of Behavioral Economics
Lecture – 33
Hedonic Framing, Acquisition Utility, and Transaction Utility
Prof. Sujata Kar
Associate Professor
DEPARTMENT OF MANAGEMENT STUDIES IIT ROORKEE
Hedonic Framing, Acquisition Utility, and Transaction Utility
Module 33
2
Hedonic Framing
• We discussed the derivation of the following principles of
hedonic framing used to evaluate joint outcomes to
maximize utility:
1. Segregate gains (because the gain function is concave).
2. Integrate losses (because the loss function is convex).
3. Integrate smaller losses with larger gains (to offset loss
aversion).
4. Segregate small gains (silver linings) from larger losses
(because the gain function is steepest at the origin, the
utility of a small gain can exceed the utility of slightly
reducing a large loss).
Ref: Thaler, Richard H. (1999). 3
Hedonic Framing
• Most people share the intuition that leads to
these principles.
• That is, if you ask subjects 'Who is happier,
someone who wins two lotteries that pay $50
and $25 respectively, or someone who wins a
single lottery paying $75?' 64% say the two-
time winner is happier.
• A similar majority shared the intuition of the
other three principles.
Ref: Thaler, Richard H. (1999). 4
Hedonic Framing
• These principles are quite useful in thinking about
marketing issues.
• In other words, if one wants to describe the
advantages and disadvantages of a particular product
in a way that will maximize the perceived
attractiveness of the product to consumers, the
principles of hedonic framing are a helpful guide.
• For example, framing a sale as a 'rebate' rather than a
temporary price reduction might facilitate the
segregation of the gain in line with principle.
Ref: Thaler, Richard H. (1999). 5
Example
• Yesterday, you had a decent day: you first received a
₹4800 tax refund, and then an old friend repaid a ₹2700
loan you had forgotten about.
• Considering the usual prospect theory value function and
parameter values find out
a) If you integrate the two gains, what is the total
value?
b) If you segregate the two gains, what is the total
value?
c) From the point of view of value, is it better to
integrate or to segregate?
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Solution
• Following PT value function, for gain since r = 0
and .
a) When the gains are integrated, the total
value =(4800 + 2700)0.88 = 2570.71
b) When the gains are segregated, the total
value = 48000.88 + 27000.88 = 2781.94
c) From the point of view of value, it is better
to segregate as recommended by the
hedonic editing hypothesis.
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The Failure of The Hedonic Editing Hypothesis
• It would be convenient if these same principles
of hedonic framing could also serve as a good
descriptive model of mental accounting.
• Formally, if the symbol '&’ is used to denote
the cognitive combination of two outcomes,
then hedonic editing is the application of the
following rule:
v(x & y) = Max[v(x + y), v(x) + v(y)]
Ref: Thaler, Richard H. (1999). 8
The Failure of The Hedonic Editing Hypothesis
• The hypothesis that people engage in hedonic
editing has obvious theoretical appeal, but
some thought reveals that it cannot be
descriptively correct.
• Consider the jacket and calculator problem
again. If the $5 saving were coded in a utility-
maximizing way, it would be segregated in
either case, but that is inconsistent with the
data.
Ref: Thaler, Richard H. (1999). 9
The Failure of The Hedonic Editing Hypothesis
• Furthermore, there must be some limits to
our abilities to engage in self-deception. Why
stop at segregating the $5 gain? Why not
code it as five gains of $1?
• Nevertheless, hedonic editing represents a
nice starting point for the investigation of
how people do code multiple events.
Ref: Thaler, Richard H. (1999). 10
The Failure of The Hedonic Editing Hypothesis
• Thaler & Johnson examined the preference
for temporal spacing in two financial
outcomes.
• If a subject wanted to segregate the
outcomes x and y, he would prefer to have
them occur on different days, whereas if he
wanted to integrate them, he would prefer to
have them occur together.
Ref: Thaler, Richard H. (1999). 11
The Failure of The Hedonic Editing Hypothesis
• The hedonic editing hypothesis would be supported
if subjects preferred temporal separation for cases
where the hypothesis called for segregation, and
temporal proximity when integration was preferred.
• For gains, the hedonic editing hypothesis was
supported. A large majority of subjects thought
temporal separation of gains produced more
happiness. But, in contrast to the hedonic editing
hypothesis, subjects thought separating losses was
also a good idea.
Ref: Thaler, Richard H. (1999). 12
The Failure of The Hedonic Editing Hypothesis
• The intuition for the hypothesis that people
would want to combine losses comes from the
fact that the loss function displays diminishing
sensitivity. Adding one loss to another should
diminish its marginal impact.
• By wishing to spread out losses, subjects seem
to be suggesting that they think that a prior loss
makes them more sensitive towards subsequent
losses, rather than the other way around.
Ref: Thaler, Richard H. (1999). 13
The Failure of The Hedonic Editing Hypothesis
• In other words, subjects are telling us that they are unable to
simply add one loss to another (inside the value function
parentheses). Instead, they feel that losses must be felt one
by one, and that bearing one loss makes one more sensitive
to the next.
• To summarize, the evidence suggests that the rules of
hedonic framing are good descriptions of the way people
would like to have the world organized (many small gains
including silver linings; losses avoided if possible but
otherwise combined). People will also actively parse
outcomes consistent with these rules, with the exception of
multiple losses.
Ref: Thaler, Richard H. (1999). 14
Reference Outcomes
• Suppose, someone is expecting x but receives 𝑥+∆𝑥.
• Let us define reference outcome as (𝑥 + ∆𝑥 : 𝑥)
• The question then arises how to value such an outcome.
• Assume that the expected outcome was fully anticipated
and assimilated. This implies that v(x : x) = 0.
• A person who opens his monthly pay envelope and finds it
to be the usual amount is unaffected.
• What if ∆𝑥≠0? Is it evaluated alone or in conjunction with
the expected value?
Ref: Thaler, Richard H. (1985). 15
Reference Outcomes
• For example, suppose I expected a Diwali bonus
of ₹10000 and I received it duly.
• However, a week later I received a call telling
me that the bonus was actually ₹8000 and due
to error in the system, some accounts have
received higher amount. I have to return ₹2000.
• On the other hand, my friend expected the
same bonus but received ₹8000.
Ref: Thaler, Richard H. (1985). 16
Reference Outcomes
• It is evident that between me and my friend, I
will be more upset because I would code the
situation as a loss of ₹2000 while for my friend
it is a reduction in gain by ₹2000, i.e. ].
• This concept can be used to model a buyer’s
reaction to a market price that differs from the
price he expected.
Ref: Thaler, Richard H. (1985). 17
Acquisition and Transaction Utility
• What happens when a consumer decides to buy
something, trading money for some object?
• One possibility would be to code the acquisition
of the product as a gain and the forgone money
as a loss. But loss aversion makes this frame
hedonically inefficient.
• Suppose, you are feeling thirsty and willing to
spend ₹40 on a bottle of water. If the bottle
costs you ₹30, you are definitely better off.
Ref: Thaler, Richard H. (1999). 18
Acquisition and Transaction Utility
• However, you wouldn’t make the purchase if the
payment were cognitively multiplied by 2.25 (an
estimate of the coefficient of loss aversion). This
thinking has led researchers to reject the idea
that costs are generally viewed as losses.
• Instead, it is proposed that consumers get two
kinds of utility from a purchase:
1. Acquisition Utility
2. Transaction Utility
Ref: Thaler, Richard H. (1999). 19
Acquisition Utility
• Acquisition utility is a measure of the value of the good
obtained relative to its price, similar to the economic
concept of consumer surplus.
• Conceptually, acquisition utility is the value the consumer
would place on receiving the good as a gift, minus the
price paid.
• Transaction utility measures the perceived value of the
'deal’.
• It is defined as the difference between the amount paid
and the 'reference price' for the good, that is, the regular
price that the consumer expects to pay for this product.
Ref: Thaler, Richard H. (1999). 20
Acquisition and Transaction Utility
• Consider the following scenario-
• You are lying on the beach on a hot day. All you have to drink is
ice water. For the last hour, you have been thinking about how
much you would enjoy a nice cold bottle of your favorite brand
of beer. A companion gets up to go make a phone call and offers
to bring back a beer from the only nearby place where beer is
sold (a fancy resort hotel) [a small, run-down grocery store]. He
says that the beer might be expensive and so asks how much
you are willing to pay for the beer. He says that he will buy the
beer if it costs as much or less than the price you state. But if it
costs more than the price you state he will not buy it. You trust
your friend, and there is no possibility of bargaining with the
(bartender) [store owner]. What price do you tell him?
Ref: Thaler, Richard H. (1999). 21
Acquisition and Transaction Utility
• Two versions of the question were administered, one
using the phrases in parentheses, the other the
• phrases in brackets. The median responses for the
two versions were $2.65 (resort) and $1.50 [store] in
1984 dollars.
• Three prices are introduced
– The actual price charged for some good z, call it p
– The value equivalent of z,
– The reference price for z, p* that is, the regular
price that the consumer expects to pay for this
product
Ref: Thaler, Richard H. (1985, 1999). 22
Acquisition Utility
• Now define acquisition utility as the value of the
compound outcome
• The associated value scale will be generally
coded as the integrated outcome
• where the cost of goods sold is not treated as a
loss as it will be hedonically inefficient.
• Acquisition utility is the net utility that accrues
from the trade of p to obtain z.
Ref: Thaler, Richard H. (1985). 23
Transaction Utility
• The measure of transaction utility depends
on the price the individual pays compared to
some reference price, p*.
• Formally, it is defined as the reference
outcome , i.e. the value of paying p when
the expected or reference price is p*.
• Total utility from a purchase is just the sum of
acquisition utility and transaction utility.
Ref: Thaler, Richard H. (1985). 24
Transaction Utility
• Thus the value of buying good z at price p with reference
price p* is defined as w(z, p, p*) where
• Now going back to the beach and drink example, people are
willing to pay more for the beer from the resort because the
reference price in that context is higher.
• This effect cannot be accommodated in a standard economic
model because the consumption experience is the same in
either case; the place of purchase should be irrelevant.
• Thus, transaction utility explains the differences in the prices
of the same product at different locations that a consumer is
willing to pay.
Ref: Thaler, Richard H. (1985). 25
Transaction Utility
• The addition of transaction utility to the purchase
calculus leads to two kinds of effects in the
marketplace. First, some goods are purchased
primarily because they are especially good deals.
• Most of us have some rarely worn items in our
closets that are testimony to this phenomenon.
Sellers make use of this penchant by emphasizing
the savings relative to the regular retail price
(which serves as the suggested reference price).
Ref: Thaler, Richard H. (1999). 26
Transaction Utility
• In contrast, some purchases that would
seemingly make the consumer better off may
be avoided because of substantial negative
transaction utility.
• The thirsty beer drinker who would pay $4 for a
beer from a resort but only $2 from a grocery
store will miss out on some pleasant drinking
when faced with a grocery store charging
$2.50.
Ref: Thaler, Richard H. (1999). 27
References
• Thaler, Richard H. (1985). Mental Accounting and Consumer
Choice, Marketing Science, 4, 3, pp. 199-214.
• Thaler, Richard H. (1999). Mental Accounting Matters. Journal
of Behavioral Decision Making, 12, 183 – 206.
• Wilkinson, N., & Klaes, M. (2017). An introduction to
behavioral economics. Bloomsbury Publishing.
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Thank You