Welcome Customer Centric Systems Bounded Rationality Jonathan D. Wareham

Bounded Rationality The limitations of human mental abilities that prevent people from foreseeing all possible contingencies and calculating their optimal behavior. Also includes limitations of human language that prevent people from communicating things that are known. We assume agents are rational, but only sort of rational Theoretical garbage can Herbert Simon: Sciences of the Artificial 1969

Fairness - Retaliation Negative Reciprocity & Envy: You hurt me, I will hurt you back! I will even take pleasure in it making you suffer loose something at my expense. Explanations: Comes from survival instincts in nature Only in very simple societies do we find less negative reciprocity (people are happy with relatively small shares of money).

Altruism & Fairness Economist world view based on self interested behavior. I help you, even when I get nothing back for it.. How do we explain it? Why don’t companies reduce salaries in hard times? The fire people instead

An experiment Imagine you are stranded on a beach on a sweltering day and that someone offers to go for their favorite brand of beer. How much would they be willing to pay? Subjects agree to pay more if they are told that the beer is being purchased from an exclusive hotel rather than from a rundown grocery. It strikes them as unfair to pay the same. But a beer is a beer and should be worth the same??? Social preference: I accept prices that I feel are fair to you…

Buying a house I am selling my house for 350,000 If you knew I bought it 3 years ago for 320,000, would you think it is a good deal? If you new I bought it 3 years ago for 150,000, would you think it is a good deal?

What is the average rainfall of New Zealand? 45cm 55cm 63cm 79cm 114cm 123cm 156cm

The Law of Small Numbers – Weber’ law (people are petty…) I. You are buying a glass of orange juice. You can buy it here for 4 Euro, or walk across the street and buy it for 3 Euro. What do you do? II. You are buying a big screen TV. You can buy it here for 800 Euro, or walk across the street and buy it for 799 Euro. What do you do? III. the impact of a change in intensity of a stimulus is proportional to the absolute level of the original stimulus. In financial terms, a $500 gain on a $100 investment is greater psychologically than a $500 gain on a $1000 investment.

Time You are going to order a new BMW for 60,000 Euro. The car dealer A tells you that you can get the car delivered in 7 days. Car dealer B, who is 4 blocks away, tells you the car can be delivered in 3 days. Do you walk down the street to the other car dealer – price and other options being equal?

Time You are going to order a special BMW for 140,000 Euro. The car dealer A tells you that you can get the car delivered in 94 days Car dealer B, who is 4 blocks away, tells you the car can be delivered in 90 days. Do you walk down the street to the other car dealer – price and other options being equal?

Procrastination Scenario A –May 1: Work 7 hours –May 2: Relax Scenario B –May 1 Relax –May 2 Work 7.7 hours –Today is April 30 th - which option would you choose?

Procrastination Scenario A –August 1: Work 7 hours –August 2: Relax Scenario B –August 1 Relax –August 2 Work 8 hours –Today is April 30 th - which option would you choose?

What is the average rainfall of New Zealand? 63cm 79cm 114cm 123cm 156cm 164cm 178cm

Framing Effects People base their decisions on the references given Extremes aversion 2 nd cheapest wine most expensive

Endowment Effects What would you pay for this chair? Euro fine How much will you sell this chair for? Euro???

Investors Alex invested 100,000 Euro and gained 27,000 for a total of 127,000 Euro. Anne invested 300,000 Euro and lost 39,000 for a total of 261,000 Euro. Who is happier? Why?

Prospect Theory

Prospect Theory Says 1 unit of loss hurts about twice as much as 1 unit of gain. So….We are loss averse What would you rather have; 10 Euro today, or 5 Euro today and 5 Euro next week? Changes are more important than absolute levels What is better – you crash your car once and it costs you 1000 Euro. You crash your car twice and it costs you 400 and 600 Euro respectively.

Changes.. What is happiness? Are rich people really happier? (Of course they are) We anchor everything to our current status. Sooo What: Combine losses, spread out gains We tend to hold onto loosing stocks..

...Decisions Are Not Always “Rational”

Price Perception Issues are Complex... More Acceptable Pricing –Product-Based –Open –Discretionary –Discounts and Promotions –Rewards Less Acceptable Pricing –Customer-Based –Hidden –Imposed –Surcharges –Penalties