Edited by Victor J. Tremblay, Elizabeth Schroeder and Carol Horton Tremblay
Relative thinking is a behavior that has been documented in various experiments in which people consider relative price differences in situations where only absolute price differences are relevant. One example is that more people are willing to spend a certain amount of time to save a certain amount of money when buying a cheap good than when buying an expensive one, due to the higher percentage saving. This violates the correct economic decision, which is to compare the time spent to the money saved, implying that the good’s price and the percentage saved are irrelevant. Further studies have shown a similar behavior when people consider differentiated goods that differ in price and quality. People are affected by the relative price difference and consequently are willing to pay more for the same quality improvement when the good’s price is higher. Theoretical models have shown that relative thinking has implications for firm pricing, and empirical evidence about price dispersion is consistent with firms that respond to relative thinking of consumers. This chapter reviews the literature on relative thinking with an emphasis on its relationship to topics in industrial organization and discusses some of the implications of relative thinking.
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