Relative Thinking and Consumer Choice

Fixed differences appear smaller when compared to large differences. Professor Schwartzstein has proposed a model of relative thinking, in which a person weighs a given change by less when he compares it to a larger range. Relative thinking implies that a person is less likely to exert effort in a money-earning activity if he had expected to earn higher returns or if there is greater income uncertainty. Relative thinking also induces a tendency to overspend, and for a person to spend more freely if she is infrequently allotted large amounts to consume rather than frequently allotted small amounts. The model clarifies issues ranging from why insurance can encourage investment to the optimal scheduling of entitlements distributions.