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10 - 3 - (3) Pricing Strategies 3- Psychological Factors (9-47).txt

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[MUSIC] So let me introduce the concept of means all accounting which I think is really fascinating for pricing. And here's the example I want to give as I mentioned it was developed my Richard Thalor, who's a professor at the University of Chicago. And he proceeded people with the following scenario. Said, imagine an individual, let's call him Mr. A, and Mr. A has just won two tickets in lotteries. He's kind of a lucky guy, he won one ticket for $50 and another ticket for 70 for $25. So he's w
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  [MUSIC]So let me introduce the concept of meansallaccounting which I think is reallyfascinating for pricing.And here's the example I want to give as Imentioned it wasdeveloped my Richard Thalor, who's aprofessor at the University of Chicago.And he proceeded people with the followingscenario.Said, imagine an individual, let's callhim Mr. A,and Mr. A has just won two tickets inlotteries.He's kind of a lucky guy, he won oneticket for $50 and another ticket for 70for $25.So he's won two separate lotteries, valuedat $75 together.Mr. B let's call him Mr. Brown, he also ispretty lucky he won a ticket for $75.So from a strictly economic point of view,both ofthese gentlemen have had their wealth goup by $75.So if we believe that people arecompletely rational, then thefact that both of these gentlemenincreased their wealth by $75.And theyshould be equally happy, but when hepresentedthis to individuals like you and I in anexperiment and asked us to say, who do wethink is happier Mr. A or Mr. B?We all think Mr. A is happier and thereason we think that is when you getgood news like win four games, it's betterfor that good news to be spread aroundokay.So think about if you had for your wife orhusband or someone else in your familysons or daughters youwanted to buy them gifts for Christmas.And you bought them three gifts forChristmas, would you wrapthem all in one big box or would youseparate them out?I think we all know at least in westernculturewould rather separate them out so whennews is good.You want to spread it all around, okay, solet's continue with this example.What about if news is bad?So in this case, Mr. A in the experimentreceived two unfortunate letters from twodifferent tax authorities.The federal government of the United  States say, sorryMr. A, you owe an extra $100 on yourtaxes.The state of Pennsylvania also sent him aletter saying, sir you owe $50 onyour taxes so the poor guy has to cough up$150 to the tax authorities.Now Mr. B also received some bad news, heowes $150 in tax, but only to the federalgovernment.So again we have two individuals who haveboth been given the samenegative information they have to pay$150.But because, again Mr. A has received twonegative hits, people like youand I in the experiment think that Mr. Ais going to be less happy.So this is exactly the opposite inference.When you've got bad news, you should lumpit all together.Good news should be separated around.So what does this mean for pricing?Well imagine that youra company and you charging customers a lotof different things three or fourdifferent things.You might be better off trying to givetheir price informationjust as one overall price rather thenitemizing the entire thing.And again if we think back to thefinancial crisisthere was an interesting example of thison a large scale.You might remember that the federalgovernment of the United States bailedout various banks and so on to the tune ofabout $750 billion.That's a lot of negative informationthat's a bighit, but I think people became especiallyannoyed about this.When they saw that 50 billion was going tobank A, 100 billion to this bank.And so listing things that arenegative creates a disproportionatenegative effect.So if you've got bad news, what youshould do is you should integrate it alltogether.Now what about if news is mixed.This is interesting things for pricing.So again, imagine my friend,Amy.Here at the Wharton school she likes tocome to school by bike.And, even though crime never happens inPhiladelphia, for the sake ofargument let's imagine that it does and  poor Amy's bike is stolen.It's going to cost her $180 to replace it.Chris as well again, perhaps its the samethief whoknows, he has a bike slightly better bikea $200 bike.His bike is also stolen, but Chris, on theway toget his lunch in the cafe in HuntsmanHall, he noticeson the ground a $20 bill.So Amy is out $180, Chris is out $200, buthe found 20.So he's also out $180.Well, who's happier?It turns out that Chris is actuallyhappier,because of something called the silverlining principle.Here he got negative 200, but the plus 20sort of makes him feel better.So how would we translate this intopricing?Well, if I'm trying to sell you a car for$20,000,instead of charging you $20,000, I mightbe better offcharging you $22,000, but let me give youa $2000 rebate.So I'm sure you can see how that principlekind of works.So now, I'm just going to spend a coupleof minutes introducing a very,very important psychological theory calledProspectTheory that has interesting implicationsfor pricing.I encourage you if you're more interestedin theory thanjust beyond what we're talking about tojust have a havea search for it on Google.So, prospect theory was developed by twopsychologists.The first of whom is professor Daniel[INAUDIBLE] who still teaches at PrincetonUniversity.And has written a number of otherinfluential, thingsin the area of human psychology anddecision making.His co-author was Professor Amos Tverskywho, unfortunatelypassed away, who was a professor atStanford University.And the two of them received the NobelPrize for this idea.So it's a pretty good idea.Let's see how it applies to pricing.So in standard economics, as you might  imagine, you and I are supposed to beindifferent between outcomes that have thesameexpected value, what do I mean by that?Let me give you a simple example.So let's imagine my friend Amy offers togive me a$100 bill, says, okay, David, you can havea $100 bill.Or you can take the following gamble, andthe gamble is,I'm going to toss a coin, a fair coin, ifthe coincomes up heads, I'm going to give you$200, andif it comes up tails, I'm going to giveyou nothing.So if I think about that, getting $100 forsure, that's $100, the gamble also has anexpected value of $100, because 0.5 times$200, plus 0.5 times zero is also 100.So the expected gain I'm going to get fromthese two things is exactly the same.So if I complete if I'm a completelyrational calculating person, then I shouldbeindifferent between these two options, butmaybe youhave a preference I would certainly have apreference I would take the $100 for sure.So what professors Conoman and Taverskyfound is that when options were offeredas a sure thing and there was positiveoptions like receiving money for example.People would rather have the sure thingthan the gamble even though the expectedvaluewas the same.Counted toward what we would learn intraditional economics.So they developed a new theory calledProspect Theory, that has threereally important points to it that aremissing from most other standard theories.The first one is that, people havean internal reference point where theyexpect certainthings from a stimuli, like price, andI'llexplain this with an example in a moment.The second thing is, people responddifferently to deviations from thereferencepoint, whether they are positive orwhether they are negative.And then thirdly their is something calleddiminishing sensitivitythat's a little more complex, I'll let youathose of you out there who are very
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