Introduction

Suppose you were in an upscale, yet unfamiliar, restaurant and while perusing the menu you come across your favorite dish. It sounds delicious, but it is very expensive. You convince yourself that it will be worth the price given the reputation of the restaurant: This will be something special. When the food arrives, it looks different from what you had expected. You taste it and are disappointed. The sauce that is integral to your preference for the food is all wrong. In fact, it is so bitter that it makes eating the food somewhat unpleasant. Nevertheless, you convince yourself to eat because you paid so much for the meal. Why should you let all that money go to waste?

The consumer is constantly faced with deciding what to buy and how much to buy. To make these decisions, they must take into account the potential gain or loss from the purchase. Cost–benefit analysis is a staple of economic policy analysis and business planning. This analysis requires one to tally all potential income or benefit from a project and potential cost to engage in the project. The idea is that if the planned benefit of a venture exceeds the cost, it may be a worthwhile venture to engage in. More to the point, if a set of choices are mutually exclusive (i.e., one cannot choose more than one option), then an individual or firm should choose the option with the highest net benefit, defined as total benefit minus total cost. Inasmuch as the price of a good, as well as the atmosphere, can signal quality, price can perhaps influence the expectations of the consumer. This could in turn influence the consumer’s willingness to pay for the good.

Questions of how much to consume should follow the simple economic rule of equating marginal cost and marginal benefit. So long as initial consumption produces more benefits than costs, one should consume until the cost of the marginal good increases and/or the benefit of the marginal good decreases to the point that there is zero net benefit for consumption of the next unit. If one reaches a constraint on consuming (such as finishing the entire dish one has been served) before net benefits are reduced to zero, then the consumer should consume all that is possible.

In many of our experiences we take price or atmosphere as a signal of the quality of a good. As well, we might order items in a restaurant that leave us wanting more when we have finished eating. This does not imply that price always signals quality differences, nor does it mean we should always complete a meal at a restaurant whether we like what we are eating or not. Nonetheless, in many cases people seem to react in curious ways to the pricing of goods. Often we hear of the need to “get your money’s worth” for a transaction. Such a notion can take on a life of its own, so that rather than simply losing some money, we lose the money and have an unpleasant meal to boot. In this chapter we discuss Richard Thaler’s notion of transaction utility and resulting behavioral anomalies. Transaction utility can be defined as the utility one receives for feeling one has received greater value in a transaction than one has given away in paying for the good. This leads to three prominent anomalies: the sunk cost fallacy, flat-rate bias, and reference-dependent preferences.