So, in the last video what we have

covered or at least started to look at is what we call the

prospect theory in understanding

the bounded rationality approach in the continuum of consumers decision making process.

As we have mentioned,

prospect theory has three main pillars.

First one is a value function,

the second one is called the risk function,

and the third one is called the risk reference point.

So, as you can see in the graph,

the value function is in the positive and

the negative quadrant are concave and there is at the center which is the axis,

the reference point relative to which consumers are going

to judge their product's characteristics.

Also, remember that this reference point is

important to evaluate not only the features of the product,

but also how the product has prices

or any other characteristics which might be important to the consumers.

The second aspect of prospect theory is what we're going to call framing,

this is where losses loom larger than gains.

So think about the scenario where you are seeing that you are going to pay $50

more on a product that is a $100 product being sold for $150.

At the same time, you see that the same $100 product,

let's say it's being sold at $50.

So basically one product, the same product,

once increased to $150 at other time decreased to $50.

So which one do you think you'd prefer more?

I'm pretty sure, given the theory behind prospect theory,

you will see that you definitely like the fact that the price of the product is

actually going down to $50 even though the increase to $150 is the same amount.

The third aspect of prospect theory is the risk profile.

This is where consumers actually reduce the sensitivity to changes in prices

and of course this is the

very critical when you are making a purchase in a particular category.

Let's think about another example.

Say a product was initially priced at $100,

and now the price of the product has gone up by $50 and so its price now is $150.

Another product, let's say it was priced at $1,000,

that price has also gone up by $50,

so now it's priced at $1,050.

So what do you think would be preferable to you?

Do you like the fact that the price has increased by

50% from $100 for the first product and become priced at $150,

or do you like the product which was

initially priced at $1,000 but increased the price by $50?

I'm pretty sure what you'll realize is that you'd

actually like the product which has increased by $50 but

which was initially priced to begin with a $1,000 and this is

all about diminishing sensitivity towards the pricing of a product.

The next aspect of prospect theory is framing,

but more in terms of gain and loss frame,

what we just discussed.

So usually, consumers who like the gain frame are risk averse.

So they don't want to take much risks when they are actually gaining something.

But definitely, when you are losing something,

they become very risk-seeking.

That is they want to take more and more risk and try to maximize their utility but again,

coming back to my earlier point,

it's not the utility in the economic sense but more

in terms of value of the purchase behavior.