Will I Spend More in 12 Months or a Year? The Effect of Ease of Estimation and Confidence on Budget Estimates

Abstract (via SSRN)

Consumers’ budgets are influenced by the temporal frame used for the budget period. Budgets planned for the next month are much lower than recorded expenses, while those for the next year are closer to recorded expenses (study 1). The difficulty of estimating budgets for the next year imparts low confidence, and leads to upward adjustment. When consumers’ confidence in their estimates is increased (study 2), when their natural beliefs about the relationship between cognitive ease and accuracy are reversed (study 3), or when cognitive resources are constrained (study 4), consumers no longer adjust their budgets upward for the next year.

Excerpt (Via SSRN)

When consumers plan their future spending, they often set budget limits for themselves. Budgeting involves creating distinct expense categories, earmarking money for the relevant fiscal period, and tracking expenses across these limits. Budgeting enables consumers to evaluate the affordability of goods and to allocate expenses among different categories (Heath and Soll 1996; Kivetz and Simonson 2002; Schelling 1992; Thaler and Shefrin 1981) and influences consumers’ estimates of their disposable income (Heath 1995; Heath and Soll 1996; Thaler 1999). Since perceived disposable income is highly correlated with consumer confidence and spending (Hall and Mishkin 1982; Okun et al. 1971; Tobin and Dolde 1971), budgets have a direct and substantial influence on consumer spending.

Despite the importance of budgeting for consumers, our knowledge about the budgeting process is limited. Recent research in mental budgeting has revealed how consumers perceive and categorize expenses vis-à-vis their budgets (Cheema and Soman 2006; Soman and Cheema 2001; Thaler and Johnson 1990). However, it is still not clear how consumers set their budgets. In this paper, we examine the psychological mechanisms that underlie this budget setting process. In particular, we investigate how and why budget estimates vary with the duration of the budget period. For any given budgeting task, consumers could use several different temporal frames such as the next day, the coming month, or the coming year. Normatively, the temporal frame should not affect the magnitude of budget estimates; that is, under normal circumstances, if a decision maker is estimating her budget for the next year, this amount should be equal to approximately 12 times her average monthly budget estimate. However, different temporal frames can lead to differences in judgments and decisions (Buehler and Griffin 2003; Chandran and Menon 2004; Gourville 1998; Read, Loewenstein, and Rabin 1999). Our interest specifically is in examining whether framing the budget period as the “next month” or the “next year”

Click Here To Learn About The Effect of Ease of Estimation and Confidence on Budget Estimates

About Miguel Barbosa

I run this site.

08. October 2009 by Miguel Barbosa
Categories: Behavioral Economics, Curated Readings | Leave a comment

Leave a Reply

Required fields are marked *