My name is Krista Li. I am an Assistant Professor of Marketing and the Weimer Faculty Fellow at the Kelley School of Business at Indiana University. I received my Master’s degree in International Relations & Economics from Yale University and my doctoral degree in Marketing at Texas A&M University. I conduct research on behavior-based targeting, product design, and behavioral game theory. My research has appeared in Marketing Science, Management Science, Journal of Marketing Research, Journal of Marketing, Manufacturing and Service Operations Management, and Production and Operations Management.

I have taught undergraduate, MBA, EMBA, and Ph.D. courses in the area of marketing research. For seven years, I worked in the marketing consulting industry for clients in consumer packaged goods, automotive, retail, telecommunications, and pharmaceutical industries.

Traditional economic theories make strong assumptions about how consumers behave and make decisions. They assume that consumers are perfectly rational, make decisions to maximize their own monetary utility, a consumer’s utility does not change with the context of decision making, and consumers are not affected by psychological, emotional, or social factors when making decisions.

However, in reality, consumers are human beings who have emotions, concerned about social, contextual, or psychological factors when they make decisions. As a result, consumers do not necessarily behave the same way as what the traditional economic theories predict.

Behavioral economics tries to explain and predict the systematic deviation of consumer behaviors from the predictions of the traditional economic models. Behavioral economists often modify the formulation of consumers’ utility functions by incorporating psychological, social, and contextual factors.

Behavioral economics is closely related to psychology. It is the intersection between economics and psychology. It attempts to incorporate psychology into economic models of consumer decision making.

Certainly. There are many examples of how marketing managers apply behavioral economics to improve product, pricing, promotion, and channel distribution decisions. For example, in the automobile industry, consumers’ perception of a brand is affected by the price range of the car models in the brand. If luxury carmakers such as BMW or Mercedes-Benz introduce affordable cars to extend their product line downward, it will dilute the brand’s image. For this reason, when a carmaker wants to serve both the luxury and economy segment, it is better off using two separate brand names to maintain the premium brand image of its luxury brand. For example, Toyota is the brand that targets economy car buyers and Lexus targets luxury car buyers.

Yes, I have written several papers about how consumers purchase luxury products such as cars, watches, and handbags and consume these products conspicuously to signal their wealth and social status.

In the paper titled “The Effects of a Product’s Aesthetic Design on Demand and Marketing Mix Effectiveness: The Role of Segment Prototypicality and Brand Consistency,” I and co-authors analyze 10-year of data for approximately 300 car models sold in the United States from 2001 to 2010. We use an image-processing software to analyze pictures of each car to measure its aesthetic design. We build a model to assess how design typicality of a car affects consumers’ willingness to purchase the car. Our finding shows that consumers prefer a luxury car model to look more consistent with its brand and more distinct from its competitors. The consistent design among car models of the same brand and the distinct design from competitors can enhance the brand’s image.

Sure. We learn from the traditional economic theory that demand for a regular product decreases with the product’s price. As consumers, we also know that we are more willing to purchase a regular product if the price is lower. However, the Veblen Effect suggests that for luxury products that signal wealth and social status, demand increase with price. In other words, consumers are more willing to purchase a luxury product if the price is higher.

This is because when a luxury product becomes more expensive, fewer consumers can afford the product and the product becomes more exclusive. Ownership of the product can signal to the public that the owner is wealthier, which makes wealthy consumers more willing to buy the product for the signaling value.

From the marketer’s perspective, it is smart to understand how real consumers behave to make optimal and effective marketing decisions. If consumers have systematic behavioral biases, marketers should understand such consumer behavior and respond to it by adjusting marketing strategies.

From consumers’ perspective, consumers need to be aware of their systematic bias in decision-making and correct for it to avoid being “tricked” by firms. For example, when consumers evaluate the price of a product, they should understand that they tend to use other prices in the purchase context as reference prices. Aware of this tendency, consumers should try to evaluate the product’s price independently, without referring to other reference prices. For this reason, it is useful for both firms and consumers to learn about behavioral economics to make better decisions.

Game theory is a useful tool to for researchers and marketers to analyze how consumers purchase and consume products when they exhibit behavioral biases or their decisions are affected by psychological and social factors. Understanding how consumers behave, we could use game theory to analyze how marketers should make marketing decisions including product design, pricing, promotion, or distribution strategies optimally.

For example, obesity is a global issue. Consumers often struggle with self control when they face the temptation to eat unhealthy vice goods (such as cookies, fast food, ice cream). Overconsumption of vice goods is a big contributor to obesity. To reduce obesity, various public policies require manufacturers and restaurants to disclose the nutritional information of their food and urge them to produce healthier products. In the paper titled “Pricing and Product Design for Vice Goods: A Strategic Analysis,” I and my co-author use game theory to formulate how consumers with self-control problems make purchase and consumption decisions about vice goods and how these decisions are affected by the price and unhealthiness of vice goods. Using this framework, we could analyze how product healthiness affects consumers’ overconsumption and how profit-maximizing firms should make optimal product healthiness and pricing decisions.

For example, when consumers evaluate a product’s price, they often use other price information as reference price. If a product is on sale and the current price is $100, which is a 50% discount from the original price of $200, then consumers may perceive the $100 price as a good deal, because with reference to the original price of $200, $100 appears much cheaper. That’s why stores often show an inflated original price on the price tag to make the current price look much lower.

Similarly, a car brand may carry an expensive car model, even though very few customers purchase the car model. The presence of the car model in the brand’s product line makes the other cars appear much more affordable.

I would recommend Richard Thaler’s book Misbehaving: The Making of Behavioral Economics. It covers the most common behavioral factors that consumers exhibit, that include mental accounting, self-control, fairness concerns, and loss aversion. For those who are interested in behavioral game theory, I would recommend Colin Camerer’s book Behavioral Game Theory: Experiments in Strategic Interaction. It introduces how we could apply game theory and experiments to understand how and why consumer behaviors systematically deviate from what traditional economy theories predict.