A Model of Relative Thinking

Fixed differences look smaller when compared to large differences. This basic fact meansthat choice sets distort a person’s preferences. We propose a model of relative thinking where a person weighs a given change along a consumption dimension by less when it is compared to larger changes along that dimension. In deterministic settings, the model predicts context effects such as the attraction effect, but predicts meaningful bounds on such effects driven by the intrinsic utility for the choices. In risky environments, 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. In a variant of the model, relative thinking induces a tendency to overspend, and for a person to act more impatient if infrequently allotted large amounts to consume than if frequently allotted a small amount to consume.