Modeling the Psychology of Consumer and Firm Behavior with Behavioral Economics

Abstract

Marketing is an applied science that tries to explain and influence how firms and consumers behave in markets. Marketing models are usually applications of standard economic theories, which rely on strong assumptions of rationality of consumers and firms. Behavioral economics explores the implications of the limits of rationality, with the goal of making economic theories more plausible by explaining and predicting behavior more accurately while maintaining formal power. This article reviews six behavioral economics models that are useful to marketing. Three models generalize standard preference structures to allow for sensitivity to reference points and loss aversion, social preferences toward outcomes of others, and preference for instant gratification. The other three models generalize the concept of game-theoretic equilibrium, allowing decision makers to make mistakes, encounter limits on the depth of strategic thinking, and equilibrate by learning from feedback. The authors also discuss a specific marketing application for each of these six models. The goal of this article is to encourage marketing researchers to apply these models. Doing so will raise technical challenges for modelers and will require thoughtful input from psychologists who study consumer behavior. Consequently, such models could create a common language both for modelers who prize formality and for psychologists who prize realism.