Behavioral Finance paper
junebug23
Behavioralpaper.docxThe disposition of disposable income as it relates to purchasing luxury products
Disposable income is valuable to households, investors, and businesses alike. How disposable income is disposed of can demonstrate one’s values and beliefs. Making rational decisions when using disposable income is important, so when the disposable income is used to purchase luxury goods it can be seen as irrational. Luxury goods are a great example of how irrational we can be; a delicious cup of coffee can be purchased for around $1, yet consumers will still spend 400% more and purchase a $5 cup of coffee. For an example, Starbucks coffee is a luxury good, and purchasing Starbucks is an irrational use of disposable income.
(Disposable income of the target demographic of Starbucks is….. This represents)
Rational uses of disposable income would be to save money for larger goals or to look at other methods to getting coffee. Carrying on the example of the luxury good of Starbucks coffee, there are several rational options that consumers can choose to derive the same utilitarian benefits. Coffee serves as a hot beverage, a source of caffeine in the morning for many, and also a beverage to enjoy as you visit with friends.
(Coffee can be made at home using …. and costs)
https://www.thesimpledollar.com/saving-pennies-or-dollars-making-your-own-coffee/
(Versus other brands)
https://www.cbsnews.com/news/is-starbucks-coffee-actually-that-good/
Marketing departments create a need for luxury goods. We buy luxury goods to show off to others and to feel like we belong. Starbucks uses branding to reinforce that their product is a luxury good. They don’t feature the utilitarian benefits of coffee, such as a hot beverage, caffeine, etc. Starbucks focuses on the expressive benefits so that a household may show they have the disposable income to afford a premium priced beverage.
The disposition of disposable income by purchasing luxury goods can be linked to several behavioral biases. Affinity bias, the tendency to make irrational uneconomical consumer choices based on how they believe a product will make them feel, is the most prevalent in this case. Purchasing a premium priced coffee at Starbucks gives consumers a physical object (coffee cup) that they can then show off and display to others. This makes them feel good, and as a result they continue to behave irrationally and use their disposable income for luxury coffee. The affinity bias that consumers experience when purchasing this luxury good leads them to look beyond the utilitarian benefits of coffee.
Maintaining appearances is important to those that purchase luxury goods. However, this irrational use of money can make it hard for consumers to save for other needs. Self-control bias, a behavioral tendency that causes people to fail to act in pursuit of their long term goals because of a lack of self-discipline, is present when purchasing luxury goods as future goals often include saving for retirement or for a real estate purchase. This estimated $5/ day lack of discipline leads to a lack of savings.
Many consumers purchase luxury goods when they want to treat themselves, or have extra money to spend irrationally. Mental accounting bias, people’s tendency to code, categorize, and evaluate economic outcomes by grouping their assets into any number of non-fungible mental accounts, is at play when purchasing luxury goods. The bottom line is that money is money, and there is no assets that should be considered extra, as there can be better, and more rational, uses of the funds.
Sources:
http://www.businessinsider.com/how-much-daily-cup-of-coffee-ends-up-costing-in-long-run-2017-6
Pompian, Michael. Behavioral Finance and Wealth Management: How to Build Investment Strategies That Account for Investor Biases. Second edition. 2012
