Modeling the psychology of consumer and firm behavior with behavioral economics

Drazen Prelec, and Matt Rabin for their helpful comments. We are especially grateful to the late journal editor, Dick Wittink, for inviting and encouraging us to undertake this review. Dick was a great supporter of inter-disciplinary research. We hope this review can honor his influence and enthusiasm by spurring research that spans both marketing and behavioral economics. Marketing is an applied science that tries to explain and influence how firms and consumers actually behave in markets. Marketing models are usually applications of economic theories. These theories are general and produce precise predictions, but they rely on strong assumptions of rationality of consumers and firms. Theories based on rationality limits could prove similarly general and precise, while grounding theories in psychological plausibility and explaining facts which are puzzles for the standard approach. Behavioral economics explores the implications of limits of rationality. The goal is to make economic theories more plausible while maintaining formal power and accurate prediction of field data. This review focuses selectively on six types of models used i