Effects of Spikes in the Price of Gasoline on

Behavioral Intentions:

A Mental Accounting Explanation

John Godek, PhD

Assistant Director, Business Development Center

University of Washington Bothell

Kyle B. Murray, PhD

Associate Professor

University of Alberta

June 16, 2011

Forthcoming in Journal of Behavioral Decision Making

Looking for a new car . . .

. . . but gas prices were going up

Weekly Gas Prices As of 6/13/2011

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Rollercoaster of Spikes

• Over the past 6 years gas prices have

spiked in the Summer, usually recovering

somewhat within weeks or months

• When prices do spike, consumers react

strongly

Reaction to Gas Spikes

Decreased Overall Spending

• The National Retail Federation Found:

– 75% of American consumers report high gas

prices have cut into their discretionary

spending

– 37% of Americans decreased vacation

spending to combat higher gas prices

– 36% cut back on dining out

Less Driving and More Efficiency

• Changes in lifestyles

– More people biking to work and using mass transit

– People moving closer to work

• AAA reports that nearly half of all Americans drive less, take fewer and shorter trips to combat high gas prices

• Consumer Reports found that:

– 55% consider purchasing a small car

– 38% are considering either flexible-fuel or diesel vehicles

– 50% of consumers consider purchasing a hybrid

Less Driving and More Efficiency

• Changes in lifestyles

– More people biking to work and using mass transit

– People moving closer to work

• AAA reports that nearly half of all Americans drive less, take fewer and shorter trips to combat high gas prices

• Consumer Reports found that:

– 55% consider purchasing a small car

– 38% are considering either flexible-fuel or diesel vehicles

– 50% of consumers consider purchasing a hybrid

Sample Hybrid Comparisons (From Edmonds.com)

Year Make Model Federal

Tax

Credit

True Market

Value

Hybrid

Premium

Annual

Hybrid Gas

Savings

Years to

Break Even

2010 Chevrolet Tahoe Hybrid $2,200 $47,626 $4,466 $483 9.3

2010 Ford Escape Hybrid $750 $28,261 $4,653 $543 8.6

2010 Ford Fusion Hybrid $850 $26,229 $4,745 $573 8.3

2010 GMC Sierra Hybrid $2,200 $35,792 $3,039 $442 6.9

2010 GMC Yukon Hybrid $2,200 $48,320 $3,437 $483 7.1

2010 Honda Civic Hybrid $0 $22,526 $3,281 $453 7.2

2010 Lexus RX 450h $0 $40,855 $4,942 $709 7.0

2010 Mercury Mariner Hybrid $750 $28,652 $5,350 $437 12.2

2010 Nissan Altima Hybrid $2,350 $23,824 $2,348 $364 6.5

2010 Toyota Camry Hybrid $0 $25,014 $515 $386 1.3

2010 Toyota Prius $0 $22,918 $1,994 $797 2.5

2010 Toyota Highlander

Hybrid

$0 $33,244 $5,579 $571 9.8

*Based on 15,000 Annual Miles, $3.67 per gal

Sample Hybrid Comparisons (From Edmonds.com)

Year Make Model Federal

Tax

Credit

True Market

Value

Hybrid

Premium

Annual

Hybrid Gas

Savings

Years to

Break Even

2010 Chevrolet Tahoe Hybrid $2,200 $47,626 $4,466 $483 9.3

2010 Ford Escape Hybrid $750 $28,261 $4,653 $543 8.6

2010 Ford Fusion Hybrid $850 $26,229 $4,745 $573 8.3

2010 GMC Sierra Hybrid $2,200 $35,792 $3,039 $442 6.9

2010 GMC Yukon Hybrid $2,200 $48,320 $3,437 $483 7.1

2010 Honda Civic Hybrid $0 $22,526 $3,281 $453 7.2

2010 Lexus RX 450h $0 $40,855 $4,942 $709 7.0

2010 Mercury Mariner Hybrid $750 $28,652 $5,350 $437 12.2

2010 Nissan Altima Hybrid $2,350 $23,824 $2,348 $364 6.5

2010 Toyota Camry Hybrid $0 $25,014 $515 $386 1.3

2010 Toyota Prius $0 $22,918 $1,994 $797 2.5

2010 Toyota Highlander

Hybrid

$0 $33,244 $5,579 $571 9.8

*Based on 15,000 Annual Miles, $3.67 per gal

Short Term Spikes –

Long Term Decisions

• Summer of 2008, sales of SUVs were dead. By Fall 2008 sales picking up again (Krause 2008; White 2008)

• Even with tax breaks, hybrids can be expensive, often with 6+ years to payback

• Even for long trips, gas spikes don’t add that much cost– Average fuel economy is 20-25 mpg (passenger cars and light

trucks; Bureau of Transportation Statistics)

– Average America drives 13,476 miles per year (April 2011, Federal Highway Administration); Average fuel consumption per week is approximately 10 gals.

Consumer Overreactions

• So even though gas spikes are usually relatively short lived:

– Consumers react as if they are long term

– Consumers’ decisions don’t always make economic sense

• Why?

– We propose framing of price increases as per gallon causes consumers to account for spikes differently

– If price increase were framed for specific situation instead, consumers might not react as strongly

(e.g., gas goes up $1 per gallon or the cost of a planned 500 mile trip increases by $25).

Mental Accounting

• Mental accounting is a set of cognitive processes used by individuals to organize, evaluate, and keep track of various financial activities (Thaler, 1999).

• Consumers create “mental budgets” to track expenditures. As expenses are incurred for a particular account, consumers change how much they feel they have to spend in that area

(Heath & Soll, 1996).

• Several types of mental accounts (Kahneman and Tversky, 1984):

– Topical – individual accounts used for tracking specific expenditures (e.g., entertainment, groceries, travel, etc.)

– Comprehensive – Includes overall spending and income for both current and future periods.

Gas Prices and Mental Accounts

• Gasoline is used in many different situations

• Difficult to assign price per gallon increase to all relevant

topical accounts

• Instead consumers deal with increase generally by

allocating to comprehensive account

Experiment 1

• Goal: See if differences in framing gas price increases leads to different choices

• Design: Scenario for a 1000 mile vacation trip, two functionally equivalent conditions, gas prices spike– PPG Framing: Gas price increases .97 per gallon

– PPT Framing: Gas price increases cost of trip by $50

(Trip should take 20 gallons on average each way on average)

• DV = “If you were to encounter the previously described situation, how likely would you be to cancel the trip?”

• N = 63

Experiment 1 Scenario

• “Imagine that you are planning a trip from Eugene to San Francisco (approximately 500 miles each way) in a couple weeks to visit friends and family.”

• PPG Condition

– “A couple days before you are actually going to depart for San Francisco, gas prices jump up from an average of $2.63 a gallon to an average of nearly $3.60 a gallon. You read in the newspaper that this sudden rise in gas prices is due to problems with oil production in the hurricane ravaged Southeastern U.S., combined with instability in Iraq and the rest of the Middle East.”

• PPT Condition

– “A couple days before you are actually going to depart for San Francisco, gas prices jump up and increase the cost of your trip around $25 each way. You read in the newspaper that this sudden rise in gas prices is due to problems with oil production in the hurricane ravaged Southeastern U.S., combined with instability in Iraq and the rest of the Middle East.”

Experiment 1 Results

Results of Experiment 1

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Main effect significant, p < .001

Experiment 2

• Goal: Determine if permanency of gas price increase moderates main effects

• Design: 2 (PPT vs PPG) x 2(temporary vs. non-temporary price increase)

• DV = Same as in Experiment 1

• N = 151

Experiment 2 Scenario

• Same introduction and manipulation used in Experiment 1

• Added temporary and non-temporary conditions:– Temporary: “Energy experts forecast that the rise in

fuel costs is only temporary, and that gas prices should fall back down within a month.”

– Non-temporary: “Energy experts forecast that the rise in fuel costs is not temporary, and that gas prices should climb again within a month.”

Results of Study 2

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Experiment 2 Results

Interaction, p = .004

• Replicated the findings of Experiment 1

• When price increase temporary, no difference between PPG & PPT

• Participants act like price increases are permanent rather than temporary

Experiment 3 Design

• Goal: Show role of using comprehensive mental account

• Design: 2 (PPT vs PPG) x 2(No instructions vs. Comprehensive framing instructions)

• Comprehensive framing instructions:

– “When answering the following questions, please consider what this change in gas prices will mean for other activities that you like to participate in as well as your overall lifestyle and spending.”

• DV = Same as in Experiments 1 & 2

• N = 153

Experiment 3 Results

• Replicated Experiment 1 and Experiment 2

• With comprehensive framing, PPG-PPT difference not significant

(p = .120)

• For PPT conditions, comprehensive framing participants cancelled more than those without comprehensive instructions (p = .036), making PPT participants act more like the PPG participants

Results of Study 3

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Experiment 4

MEANS (STANDARD DEVIATIONS) OF DEPENDENT VARIABLES

BY PRICE CHANGE FRAMING:

Reported Likelihood to: Price Per Gallon Price Per Trip

Cancel Trip 3.60 (1.91) 2.15** (1.43)

Have Less Disposable Income 6.92 (1.55) 5.60* (2.22)

Feel Poorer 6.00 (2.30) 4.35* (2.80)

Decrease Overall Spending 6.28 (1.74) 5.04* (2.05)

Eat Out Less 6.40 (2.16) 5.15* (2.26)

Use Alternate Transportation 5.72 (1.99) 3.54** (2.66)

Move Close to Work/School 5.48 (2.24) 3.72* (2.78)

*p < 0.05, **p < 0.01

• Similar to Experiment 1, but asked about perceptions and

behavior

Conclusion

• In four studies we find strong evidence that framing gas price increases in terms of price per gallon affects consumers’ in previous unstudied ways:

– By default consumers perceive increases in gas prices as non-temporary in nature

– Consumers feel gas prices increases will have wide ranging effects on their discretionary spending.

• We propose and find evidence that consumers react because of differences in how price per gallon increases are account for by consumers.

– Consumers tend to process such price increases more comprehensively

Implications

• Managerial and Policy Implications:

– Our research suggests that if firms or policy makers want to minimize the effects of price increases on consumer spending, then prices increases should be framed to invoke use topical vs. comprehensive mental accounts.

– On the other hand, for those wishing to encourage conservation and reduced fuel consumption, it makes sense to encourage consumers to think comprehensively.

• General Implications:

– This research suggests that topical vs. comprehensive mental accounting is an important, and somewhat overlooked, factor in consumer responses to prices and price increases.

Thank You!