Do We Really Need Behavioral Economics? YES INDEED.

Submitted by Michael Conklin, Chief Methodologist, on January 12, 2012 - 08:00

A recent blog post by Brandon Ellse on Research World’s RW Connect blog argues :

Shopper price thresholds "How can behavioural economics practically change the market research landscape? This remains less than clear to me. We’ve all heard about the experiments, their control and treatment groups beautifully poised in anticipation of the 'ta-da' moment where 'real' human behaviour is revealed like a rabbit pulled from a hat. These behavioural economics-inspired tales seem to waft over our intellectual senses, leaving us with a strange feeling of certainty that only the perception of knowledge exclusivity can bring. I won’t lie, I’m impressed. Getting at causality is no mean feat and I am often left in awe of the ingenuity of these researchers, but I want practical application and I get the feeling that you do too."

The benefit of behavioral economics is the insight it gives into the proper specification of the models we use every day in marketing research. Behavioral economic theories about how and why people overstate their estimates of frequency of purchase enable us to construct models that better predict actual behavior from the imperfect survey answers we collect. Understanding that losses loom larger than gains enables us to construct appropriate non-linear price functions in discrete choice models.

For example, behavioral economics tells us that threshold prices exist, that is, prices where exceeding them causes an unexpectedly steep decline in the price-demand function. Knowing this has enabled MarketTools to specify pricing DCM models with threshold points identified. I gave a presentation (Wildner R., and Conklin M., “Price Thresholds and Prospect Theory”, The 14th Annual Advanced Research Techniques Forum of the American Marketing Association) showing that pricing models with thresholds always predicted better than models without. Using behavioral economics theories allowed the specification of a better, more predictive model.

The linear models of the past have worked the best when the true form of the model was close to linear. This provides a bias towards small incremental changes because small changes are going to be approximately linear. To understand the potential for large gains or losses we need to have the right underlying functional form and behavioral economic theories help us get there.

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