As we have seen in the last video,
a consumer goes through a continuum of decision processes,
starting from the rational approach and going towards the motivation approach
which are basically two extremes in the decision-making process.
Somewhere in between is the so-called bounded rational idea approach
which is based on what is known as prospect theory.
This was proposed by two guys, Kahneman and Tversky for
which actually Kahneman got a Nobel prize.
This prospect theory is based on the premise that consumers doesn't
necessarily go into the whole process of maximizing utility subject
to the budget constraint because they have limited processing capability.
They can't process all the information they have available at their disposal and
that's why they resort to some simplified decision making methods.
Well, they take shortcuts based on some of the idiosyncratic issues
which a product has.
Or maybe at the brand level or maybe even at a category level.
The three main pillars of this prospect theory are the value function,
the risk function, and reference points.
What is the value function?
Value function is basically how much the consumer values a product
in terms of the utility which is given to him.
Of course, he can't measure the utility, so
that is where this simplified version rule comes in.
The second one, which is called the risk function.
This is where consumer weighs the risks which
are probably involved in purchasing the product.
Some products are more risky to purchase.
May be think about the situation where you're seeing suddenly a very good deal
on a particular electric gadget.
But, ultimately it might turn out that the deal is too good to be true.
But you are willing to take the risk in certain cases while making the decisions
because you don't want to go through the entire process of
maximization before making your purchase decision.
And the third aspect of this prospect theory is what is called reference points.
This is where consumers take certain exemplars that are points which
they have some idea about from before, and
based on those reference points they evaluate the pros and
cons of a particular product before making their final purchase decision.
In the next video,
we are going to dig deep into these three aspects of prospect theory.
That is the value function, risk function, and reference points.
And understand what each one of these does in the entire decision making process,
based on bounded rationality.
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