Bargain or rip-off?

If you were laying on a beach, craving for a bottle of cold water, how much you would be willing to pay for it? Supposedly someone approached you and offered one for $5—that price would seem ridiculous if you knew that the same bottle of water in a grocery store costs $2. But would you feel better paying same amount in a fancy restaurant nearby, known for its large prices?

Transaction utility, a term developed by Richard Thaler, is a difference between the actual price and the price that you’re expect to pay. In the example above, we experience a negative transaction utility—we spend more than we expected to pay. The difference between buying from a person and from a fancy restaurant is that even we felt ripped-off in both situations, we feel a bit better on a latter because we already expected to spend more than a retail price.

Transaction utility could go other way as well: suppose you were going to buy a toaster for $42, but you learned that in another shop there is the same item for $32. Would you spend 15 minutes going to another shop to save $10? Same question applies when you were about to buy an oven for $214, but in another shop it costs $204. Does it feel its still worth going to another shop? Essentially, we feel that saving $10 for a toaster is a better deal than saving $10 for an oven, even if in both of these situations we save same amount of money.

Whenever we find ourselves in situations like these, it’s worth remembering transaction utility effect. We, as humans, aren’t always rational, and we could save more money only if we look through a different perspective.