The Economic Theory and The Prospect Theory

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As portrayed by the article, the economic theory illustrates how consumers choose what to do and how to do it. The author implies that consumers’ behavior entails the integration of both normative and positive concepts. Nonetheless, the economic theory does not hold in all situations; hence, may lead to systematic errors while predicting the consumer behavior. It is for this reason that the author proposes another theory, i.e., the prospect theory as an alternative concept. The writer implies that this theory carters for well-defined moments when many consumers act in a way that contradicts the economic argument. The author critiques the economic approach using several aspects, i.e., opportunity costs, search behavior, regret, sunk costs, and pre-commitment and self-control. Utilizing different elements of problems involving consumers, the author provides situations where customers are likely to stray from the forecasts of the normative concept.

Importance of the Main Points

The author’s sentiments regarding understanding the situations where the economic theory does not hold are vital. For instance, drawing from the first lesson of economics, i.e., all costs are opportunity costs; hence, ought to be considered similar to out-of-pocket expenses. Nonetheless, the writer strives to show a distinction between the two; an essential aspect of economics. The point is quite crucial, especially since it expounds on the endowment effect utilized in various aspects of the business. The author also elucidates on the facets of self-control, endowment effect, and sunk costs, and how they influence a consumer’s decision. Understanding the main points will help to comprehend why the prospect theory should be embraced.

Relevance of the Main Point

The endowment effect is a concept, which implies that individuals attribute more value to things they own. A good analogy can be drawn from the purchasing and selling of football players. Once a player is drafted, he becomes a fans’ endowment, and when traded or sold, the player is treated as a loss. Nonetheless, when a player is a free agent, they tend to drop out of the fans’ endowment bracket. At this juncture, the fans accept that the player can only be recouped at a considerable out-of-pocket expense. The author utilizes practical examples to illustrate the relevance of the prospect theory, particularly in situations where the economic theory does not hold. Evidently, people tend to give more value to things they own than those they do not. For instance, is a player belongs to our team, then the endowment effect heightens his value significantly.

Main Conclusions

Overall, the author implies that different situations require varying economic decisions; hence, the economic concept is not ideal in every case. In one instance, the endowment effect influences how we perceive a commodity, i.e., whether valuable or not valuable depending on the ownership. The writer also implies that our economic decisions are sometimes guided by the sunk costs; charges such as rent, which is already incurred and cannot be refunded. This approach contradicts the economic model, which infers that only benefits and incremental costs should influence decisions. The author also concludes that in some instances, customers voluntarily limit their choices. The knowledge of choosing induces costs, which can be eliminated or lessened by limiting the option set in advance. Responsibility and guilt can define how one makes economic choices. Another important conclusion is that the issues of self-control can only be resolved via the comprehension of pre-commitment. For example, investment products like exercise and education portray the self-control deliberations in pricing policies.

January 19, 2024

Economics Life

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