THEORY

Mental Accounting Decision Making The Value Function

Traditional economic analyses of decision making under risk generally believe that consumer will try their best to maximize final expected utility. Several empirical research stand by, however, consumers broadly violate expected utility theory in their routine decision making (Camerer 1995, Starmer 2000). For example, measure result of utility that under expected utility is often result in a contradictory (Hershey & Schoemaker 1985).

Obviously, using biased utilities to predict decisions will be distorted. (Abdellaoui, Bleichrodt, et al. 2007) The latest research on human consumption behavior judgment and decision-making comes from cognitive psychology and behavioral economics, which have reconceived completely rational homogeneous economics into less ideal sapiens (Tversky and Kahneman 1981).

To make utility theory more rigorous, Kahneman and Tversky (2003) had proposed the value function, confirm that with a defined reference point, people are generally showing the value in a concave way for gains and commonly convex for losses. In other words, value decline steeper for losses than incline for gains. The concept is similar to an individual’s aversion to losses that may increase sharply near the loss. Researchers point out that in the specific range, for example, 10 dollars, the value decrease of losing 10 dollars will obviously larger than the value increase of gaining 10 dollars.

Figure 2.1 prospect theory value function. Adapted from “Kahneman and Tversky (2013), Prospect theory: An analysis of decision under risk, Econometrica, 47, 279.”

The role of the value function in mental accounting is to describe how events are perceived and coded in making decisions (Thaler 1999). Continuing this concept, prospect theory is widely regarded as more suitable for predicting the behavior of irrational human beings. One important reason that prospect theory is more proper in mental accounting than expected theory is loss aversion: When people expound decision-making outcomes as gains and losses that comparative to a reference point, it is apparently more sensitive to losses than to commensurate gains (Abdellaoui, Bleichrodt, et al. 2007). An important reason why prospect theory is more suitable for mental accounting evaluating than expected utility theory is loss aversion. That is, when the decision result is interpreted as a gain or loss compared to a reference point, it is clear that losses are more sensitive than equivalent gains.

Therefore, researchers must consider people's perceptions of the difference between loss and gain when predicting consumer behavioral decisions.

Hedonic Framing in Mental Accounting

Base on the prospect theory value function, it is possible to build a model of how people code combinations decisions (Kahneman & Tversky, 1979). As the assumption of expected theory, researchers who use prospect theory also assume customers will try their best to maximize utility. Kahneman and Tversky (1979) formulated the idea of prospect theory, clarifies that consumers are naturally risk-averse. The discussion is specifically being significant when addressing situations with potential gains and of course risk-seeking when making decisions with potential losses.

Given the shape of the value function, Thaler (1999) advocate the following principles of hedonic framing, which is taken as an important part in mental accounting to evaluate joint outcomes to maximize utility: (1) Segregate gains and integrate losses (because the gain function is concave and the loss function is convex). (2) Integrate smaller losses with larger gains (in order to offset loss aversion). (3)Segregate small gains from larger losses (suggested by the gain function is steepest at the origin) (Thaler, 1999).

This prediction is supported in several experimental studies, for instance, Thaler (1985), Thaler and Johnson (1990), and Lim (2006). For example, Lim (2006) mentioned that as money has different meanings over time, monetary losses and gains also imply differ meaning such that investors frame losses and gains inconsistently. The hedonic frame principals illustrate the way of evaluating the decision-making process with joint outcomes and explore the informative of loss aversion during the process.

Following prefer review, the change of utility in pay a payment will steeper then gain something. And people will prefer to integrate small losses to a bigger loss. In this research, the more frequently but small losses will be the form of paying by months, and paying by years will represent the integration and bigger loss. As hedonic frame suggests (Thaler, 1999), and an obvious preference for paying by years is in our expectation.

H1: Consumers should prefer to pay by years than pay by months, as a smaller but more frequent loss payment.

Product Familiarity The Failure of The Hedonic Editing Hypothesis

Researchers doubt the principles of hedonic framing can be applied in any situation.

Thaler and Johnson (1990) test the hedonic editing hypothesis in a series of experiments, One method they use is to ask people about their time delay preferences. In their questionnaire, subjects were asked to select two designated financial results. The question is which option implies more enjoyable, receiving two additional rewards on the same day, or two events separated by a week or two? The question is testing the subject's perception of the time interval. So if the respondent wants to separate the results, then he wants the results to happen at different times, and if he wants to integrate the results, then he wants the results to happen at the same time.

The focus of Thaler and Johnson's research is that if the hedonic editing hypothesis is supported, then under the premise of the need for integration, if the assumption requires separation and time is close, then subjects will prefer time separation. As a result, the hedonistic editor's hypothesis was supported in order to gain revenue. Most subjects thought that the temporal separation of gains made them happier.

However, subjects thought separating losses was also a good idea, which is in contrast to the hedonic editing hypothesis. The concept of the hypothesis that people would want to integrate losses comes from the point that the loss function displays diminishing sensitivity (Thaler and Johnson, 1990). In other words, the result shows that respondents think they are unable to simply add one loss to another. On the contrary, they prefer the losses should be felt one by one that bearing one loss makes one more sensitive to the next.

Sum up, the evidence presents the principles of hedonic framing when focusing on gains. But loss aversion persuades that the pain of losing is psychologically about twice as

powerful as the pleasure of gaining. And people are naturally more focusing on loss then the gains can be taken at the same time (Kahneman and Tversky, 1979). Moreover, Thaler concludes that loss aversion is even more important than the prospect theory value function would suggest, as it is difficult to combine losses to diminish their impact. At the same time, hedonic framing will not always correspond with consumer behavior when they are not that kind sure of their loss.

In our research, in order to weaken the descriptive framework of gains and loss, we present the product and price at the same time and give the product a specific description.

Also, we consider other moderating variables in our research architecture.

Acquisition Utility & Transaction Utility

When decide to buy something, it means trading money for some object. To extend the hedonic frame to routine consuming behavior, Thaler (1999) argued that code the acquisition of the product as a gain and the forgone money as a loss is not proper, due to loss aversion makes the frame hedonically inefficient. This thinking has been supported by both Kahneman and Tversky (1984) and Thaler (1985) to reject the idea that costs are generally viewed as losses.

Instead, researchers propose that consumers get two kinds of utility from a purchasing transaction: acquisition utility and transaction utility.

Acquisition utility is relative to the price that consumers need to pay for a transaction of the good, similar to the economic concept of consumer surplus. In other words, acquisition utility is the value that consumers receiving the good as a gift minus the price paid.

Transaction utility measures the perceived value of the clinch. First, there must be a reference price, which might be the mean of the price that consumers purchase before. That is the regular price consumer expects to pay for this product. Contract to the reference price, consumers may increase the price acceptance in different cases. One famous example followed by Thaler (1985) is that consumers will agree to pay more for a bottle of beer in a villa’s shop, cause it is the only place to sell beers around. The addition of transaction utility, some goods are purchased only because they are especially good deals. In contrast, because of substantial negative transaction utility, some purchases would be refused even seem to make the consumer better (Thaler 1999).

Product Familiarity

In this research, for paying a payment, the behavior means a loss in money account and also a gain in a specific product or service entity account. For the loss side, pay by years is an integrated and bigger loss compare to pay by months. On the other hand of the gain side, pay by months is that you own unlimited usage in one month, and pay by years is the full service for one year.

For the purpose to adjust the bias of hedonic framing, product familiarity is taken as a moderator variable during the decision making process. Previous work has documented the relationship between product familiarity and consumer decision. Park & Lessic (1981) declare that decision-maker at a moderate level of familiarity shows significantly less confidence than the decision-maker at a high level of familiarity.

Also, as an indicative variable, product familiarity is easily operating. Conclude with several previous research, Prentice (2004) mentioned familiarity can be informational from written, audio and visual sources or experiential from first-hand experiences. Include consumers' knowledge, experience and the absorbance of influences information, product familiarity influences consumers’ decision making (Brucks, 1985; Lynch et al., 1988; Tasci and Knutson, 2004). Authoritative, three prior behaviors that were broadly used in testing product familiarity are (a)search experience (b)usage experience (c)ownership status. (Park

& Lessic, 1981).

Furthermore, product familiarity is considered an important reference to check subjects’ accuracy of their imagination decision-making. It has been believed that is related to the decision maker’s knowledge and experience of the product and it shows a moderator effect during a consumer’s decision-making process.

H2: People who have higher product familiarity will be more clear about their willingness to make the decision between pay by years or pay by months, than those have lower product familiarity.

Product Familiarity Measure

Previous research has indicated certain factors that affect product familiarities, such as product involvement, product knowledge, and previous experience. Two major methods are available for operationalizing and measuring product familiarity: one is to measure in terms of how much a person knows about the product; the other is to measure how much a person thinks s/he knows about the product (Park & Lessic, 1981). Generally speaking,

there have been considerable effects in terms of knowledge on consumers’ involvement with products. In addition, if the customer does not have an interest in the product, they will likely have a knowledge deficiency regarding the product and consequently will feel uncertain about purchasing the product (Lin & Chen, 2006).

Rao and Monroe (1988) launched the research examined the dissimilar use of product information cues in product evaluations by differentially familiar subjects. In the research, offered a complete questionnaire to test product familiarity, which included the previous using experience, information searching experience, owing status, and product knowledge. Rather than simply asking the respondent's self-evaluation of their familiarity, a series of questions, like a test sheet, containing experience and knowledge can more objectively reflect the subject's product familiarity level. Thus, in this study, research also designs the questionnaire as a approach to test subjects’ product familiarity, which can be expected to be more conservatively.

Intertemporal Consuming Decision Making

Frederick and Loewenstein et al (2002) declare a clear definition of distinguishing time discounting from time preference. They take the term time discounting to extensively involve any reason for caring less about a future consequence, factors that diminish the expected utility generated by a future consequence are included, such as uncertainty or preference changing. And use the term time preference to much more specifically catch sight of the preference for immediate utility over delayed utility. In our research, what we are trying to show is the difference between consumers paying for the length of the year and month cycles. Therefore, time discounting is a point we pay more attention to.

Rae (1834) believed that intertemporal-choice behavior was the joint effect of factors that either encourage or limit the effective desire of accumulation. Frederick and Loewenstein, et al (2002) give another step of contracting the anticipatory-utility and abstinence perspectives that thought share the same core aspect that intertemporal tradeoffs depend on the immediate pleasure of anticipation and the immediate discomfort of self-denial. However, two perspectives clarified the variability in intertemporal choice behavior in different approaches. The anticipatory-utility perspective constitutes the variations in intertemporal-choice behavior with the differences in consumers' ability to illustrate the

future and to differences in circumstances that promote or inhibit such mental images. On the other hand, abstinence perspective expresses variations in intertemporal- choice behavior on the basis of individual and situational differences in the psychological discomfort associated with self-denial (Frederick, Loewenstein, et al. 2002). To sum up, in this view, one should observe high rates of time discounting by people who feel painful to delay gratification and specifically feel uncomfortable in the situation which deferral. As Rae (1834) infers, the one is "actual presence of the immediate object of desire."

In our research, subjects will be asked to choose between pay by months or years.

To extend the time discount aspect to loss, a consumer who has a high immediate desire implies the preference to have cash. In contrast, the one has a low immediate desire implies a low sensitivity of pay immediately or pay intertemporal.

H3: People who have a lower Intertemporal discount ratio will be less willing to pay by years then pay by months.

Discount rate measure

Several studies test the intertemporal discount rate in different ways. Bohm-Bawerk treats intertemporal choice as an allocation of consumption which among time periods was formalized a decade later by the American economist. Fisher (1930) use another economical approach that plotted the intertemporal consumption decision on a two-good indifference diagram, with consumption in the current year on the abscissa, and consumption in the following year on the ordinate. This method is praised as a clear representation of a person's marginal rate of time preference and the marginal rate of substitution at the chosen consumption bundle. The method depends on two considerations:

time preference and diminishing marginal utility (Kirby, Petry, et al. 1999). However, many economists discomfort with using the term "time preference" to include the effects of differential marginal utility emerging with unequal consumption levels during time periods (Olson and Bailey 1981).

Subsequently, a method with 27 questions launched by Kirby (1999) is broadly applied in behavioral economics. The estimate of a participant's discounting-rate parameter is made from the participant's pattern of choices across the 27 questions on the monetary-choice questionnaire. The delay discounting degree was determined by using the hyperbolic equation V = A/(1 + kD), in which k is a free parameter describing the degree of discounting (Kirby, Petry, et al. 1999). The question, for example, offered participants

a choice between "$33 today" and "$80 in 14 days." Follow Kirby’s definition, a participant with a discount rate of 0.10 would be indifferent between these two options. Therefore, a participant chose the immediate reward on this question could be inferred that this person had a discount rate greater than 0.10 (Kirby, Petry, et al. 1999)

Although for Taiwan participants, 27 alternative questions will make the questionnaire more likely to be abandoned by the testee, though might to face the difficulty motivates participants to answer, this study still decided to use this design. While following Kirby's research design, we do our best to collect credible responses.