Mental accounting in allocating capacity

Abstract

Problem definition: This study investigates a seller’s allocation of a limited resource to sequentially arriving customers when the seller is influenced by two types of mental accounting bias: prospective accounting (overestimating future revenue) and behavioral discounting (underestimating future revenue). Methodology/results: We establish structural properties on how mental accounting affects capacity allocation decisions and performance. Interestingly, whereas additional capacity consistently benefits the seller, the same does not hold true for additional demands. That is, an additional class of demand can hurt the seller, depending on the type of mental accounting. This is true even if the additional demand class has a higher reservation price than existing ones. Managerial implications: This result highlights the importance for companies to address and mitigate biases in decision makers before embarking on market expansion initiatives through promotions and advertising campaigns.