Chapter 10: The citizens' judgements of prices and inflation

Question 1

What are internal reference prices?

Answer 1

People compare the price of a product with other prices in their memory

Question 2

What are external reference prices?

Answer 2

People compare price of a product with other prices available in the environment

Question 3

What is important to remember in price comparison, specifically in comparing value? (2)

Answer 3

People compare subjective (e.g., perceived) value and not nominal value.
Consumers react to their psychological perception of prices and not face value

Question 4

Adaptation level theory of price comparison means what?

Answer 4

the evaluation of a price depends on the difference between the evaluated price and the adaptation level

• Adaptation level is a weighted mean of the prices in a given reference period. For example, you know cup of coffee costs on average 2.50 based on all prices you have come across

Question 5

Range theory of price comparison means what?

Answer 5

A target price is evaluated by taking into account the minimum and maximum reference prices. Prices are evaluated in relation to the highest and lowest price of a cup of coffee

Question 6

Range-frequency theory of price comparison states what?

Answer 6

The evaluation of a target price can be conceived as weighted average between a range-based evaluation and a frecuency-based evaluation. For example, people know in hipster neighborhoods it is more common to pay 2.5 - 4 euro’s for a cup of coffee. Based on price and frequency in hipster neighborhood

Question 7

What is wrong with ‘standard’. economic price comparison theories?

Answer 7

It is rather implausible that people would recall an entire distribution of prices when evaluating a target price.

Question 8

Prospect theory of price comparison means what?

Answer 8

People should react more strongly to price increases than price decreases

• Categorizing the situation as gain or loss in relation to a reference point changes price evaluation
• Losses have larger impact than corresponding gains

Question 9

Decision-by sampling price comparison theory means what?

Answer 9

• People have no stable internal scale for evaluating monetary changes
• During the evaluation process: a sample is derived from memory
• Memory is assumed to reflect occurrences in environment
• Judgement of price is assumed to reflect the rank of the target item in relation to the sampled item
• Naturally incorporation of frequency-based judgements

Question 10

What is norm theory in price comparison? (2)

Answer 10

(1) Evaluation takes place in relation to a set of relevant items activated in parallel
(2) If price has to be judged, the product will activate similar products and their prices that will be used for the evaluation (e.g. how much should you pay for a drink or a warm drink or a cold alcoholic drink, instead of coffee/beer)

Question 11

Factors affecting price memory and evaluation? (4)

Answer 11

(1) High/low experience with product (Category)
(2) High/low experience on price variability in the market
(2) High/low recency and frequency of exposure or purchases
(4) item distinctiveness and salience

Question 12

What are process errors in price comparison (2)?

Answer 12

(1) Prices of products like the one evaluated are more likely to be retrieved
(2) Price presentation characteristics and context

Question 13

Research has revealed difference between official inflation measures and the citizen’s perception of past price changes, particularly after a currency change. What are some of the reasons for this (5?)

Answer 13

(1) Most people don’t purchase the typical basked used to calculate official measured
(2) Wordings used in the survey
(3) Availability mechanism –> memories easier to recall will have a disproportionate influence on the judgement of inflation
(4) Personal experiences –> people pay more attention to stuff they experience regularly
(5) Believing inflation to be high can generate an expectation that biases perceptions of past price changes
- After introducing EURO, people believed prices to have risen more than actual
- Potentially caused by bias in conversion: in conversion of currency prices are rounded up
- Expectations of risen prices leads people to believe prices have gone up even if this is not true

Question 14

Are citizens inflation expectations homogeneous and unbiased?

Answer 14

Perceptions are not unbiased, people tend to underestimate changes in inflation

Question 15

Do lay models of economy differ from expert models?

Answer 15

They show the same patterns, but lay models show higher averages and more variance

Question 16

Do people use available economic information efficiently?

Answer 16

People do not use information efficiently. Forecast accuracy is strongly related to someones economic literacy

Question 17

What are consequences on inflation perceptions and expectations? (5)

Answer 17

(1) 12-month inflation expectation is a significant predictor of future expenses
(2) Inflation perceptions are related to wage bargaining behaviour
(3) Perceptions of sharp increases in recent inflation are followed by immediate and durable decrease in consumption
(4) Prceptions of shard decrease in inflation are followed by more consumption
(5) higher inflation expectations affected planned savings adjustments (due to the expectation of higher interest rates)

Question 18

What are some implications for consumer policies regarding price comparison behaviour? (3)

Answer 18

(1) Prices seem to be reference based and sometimes situation-specific, thus:

• Help consumer evaluate prices of less familiair purchases by real-time comparison
• Public services like SMS or APP
• Web-based price comparison tools are good, priced they are unbiased and offer valuable information

Question 19

What are some implications for financial education on found price comparison behaviour?

Answer 19

(1) There is a strong need for financial education concerning changes in inflation rate over time and its effects
- The understanding of inflation of those with Lowe economic literacy may be rather poor. People have difficulties answering simple questions about inflation vs interest rate