Predicting Buyer-Seller Pricing Disparities

Abstract

Numerous studies have shown that compensation demanded (CD) to give up a commodity often greatly exceeds willingness to pay (WTP) to obtain the same commodity, even in incentive compatible experiments that penalize strategic misrepresentation. Observed CD/WTP disparities are too large to be reconciled with traditional assumptions of economic rationality. A prospect theory-based behavioral framework for predicting CD and WTP is proposed which produces five distinct transaction encoding rules, any one of which can in principle apply to a buyer or a seller. According to this framework, CD/WTP gaps occur when buyers and sellers encode the prospective transaction differently, and gaps can occur in multiple ways, and vary in size, depending on encoding. The transaction encoding framework was tested in two experiments. In Experiment 1, model fits to subjects' CD and WTP for lottery tickets were consistent with the hypothesis that buyers and sellers encode transaction problems differently. Moreover, the quite large observed CD/WTP gaps were explained fully by encoding: When differences between buyers' and sellers' encoding processes were taken into account, their estimated utility (value) and probability weighting functions did not differ. The present framework and results show that the widely cited endowment effect is but one of several ways in which loss aversion can give rise to CD/WTP gaps. Consistent with this broadened perspective, Experiment 2 demonstrated CD/WTP gaps in the absence of an endowment effect (and in the absence of rational economic causes). The transaction encoding framework (1) provides a structured approach for predicting and testing the effects of a variety of task factors on pricing behavior and transaction outcomes, and (2) reveals the useful property that, in many cases, the ratio CD/WTP can be interpreted as a direct measure of the degree of loss aversion.judgment, decision making, risk, preference, pricing, certainty equivalents, contingent valuation

Effects of study design characteristics on the WTA–WTP disparity: A meta analytical framework

“…12 They found support for the first hypothesis and mixed results for the second one. Similarly, Casey (1995) observes a small increase in the WTA/WTP ratio as the probability of the zero outcome increases. Therefore, we expect the WTA-WTP disparity to be higher for risky goods or payoffs.…”

“…Haab and McConnell (1997) show that estimated values depend on the assumed utility function, and even negative WTP estimations can be obtained. Adamowicz et al (1993) Tickets for Cannes commercials show 1 Anderson et al (2000) Eggs, ecological eggs 2 Banford et al (1979) Ocean pier, postal service 2 Bishop et al (1983) Goose hunting permits 1 Borges and Knetsch (1998) Scratch-win lottery tickets 1 Bowker and MacDonald (1993) Odor free air 1 Boyce et al (1992) Norfolk island pine 2 Brookshire and Coursey (1987) Density of park trees 8 Brookshire et al (1988) Raspberry juice 5 Brookshire et al (1990) Tasting sucrose octa-acetate 10 Brookshire et al (1980) Elk hunting permits 3 Carmon and Ariely (2000) NCAA basketball tickets 1 Casey (1995) Lottery 2 Chapman and Johnson (1995) 20 various items 20 Coombs et al (1967) Lottery 2 Dubourg et al (1994) Vehicle safety feature 6 Eisenberger and Weber (1995) Lottery 8 Franciosi et al (1996) Mugs 1 Garbacz and Thayer (1983) Senior companion program services 2 Gerking et al (1988) Job safety 1 Hammack and Brown (1974) Waterfowl hunting 1 Harless (1989) Lottery 2 Hartman et al (1990) Electric service reliability 9 Hogarth and Kunreuther (1989) Insurance 4 Kachelmeier and Shehata (1992) Lottery 1 Kahneman et al (1990) Mugs, pens, binoculars, chocolate bars 11 Knetsch (1989) Candy bars 1 Mantymaa (1999) Usage of undeveloped land 1 McDaniels (1992) Auto safety 1 Mellers et al (1992) Lottery 2 Morrison (1997) Chocolate bar, mugs 4 Ortona and Scacciati (1992) Labor/leisure trade off, faster/slower train 4 Peters et al (2003) Lottery tickets 4 Rowe et al (1980) At...…”

Unpacking buyer-seller differences in valuation from experience: A cognitive modeling approach

“…RL = reinforcement learning; CPT = cumulative prospect theory; IBL = instance-based learning theory Garboua, 2008) found larger overweighting of smallprobability events by sellers than by buyers. Casey (1995) fitted probability weighting functions on the individual level to buying and selling prices for monetary lotteries, and similarly obtained more strongly curved functions for sellers than for buyers. (When the functions were fitted to responses on the aggregate level, there were no buyer-seller differences.…”

“…Although the seminal investigations on the endowment effect (e.g., Kahneman et al, 1990;Thaler, 1980) involved the valuation of consumer items such as mugs and pens, many subsequent studies have turned to monetary lotteries and found a robust endowment effect there as well (e.g., Birnbaum, Coffey, Mellers, & Weiss, 1992; Birnbaum & Zimmerman, 1998;Brenner et al, 2012;Casey, 1995;Isoni et al, 2011;Kachelmeier & Shehata, 1992;Peters, Slovic, & Gregory, 2003; for a meta-analysis, see Yechiam, Ashby, & Pachur, in press). In contrast to consumer items, an advantage of lotteries is that their attributes can be quantified precisely (which is important for the modeling) and that they also allow to test for buyer-seller differences in risk attitude.…”

Buy low, sell high: Price gaps and neoclassical theory

“…We do not consider incentives to buy low and sell high that might arise because of "strategic misrepresentation" (Casey, 1995), a characteristic of preference elicitation mechanisms that do not eliminate incentives for respondents to behave strategically. Buy low-sell high strategies can also emerge in dynamic settings where decision-makers may (correctly or incorrectly) perceive advantages to behaving strategically.…”