In the intricate world of antitrust law, the definition of a relevant market stands as a cornerstone of competition analysis, yet its foundational assumptions are increasingly being questioned. This process, which identifies the boundaries of competition between firms, has traditionally relied on the model of a rational consumer. However, the growing body of knowledge in behavioral economics challenges this paradigm, a shift now formally acknowledged by regulators.
The European Commission’s 2024 Market Definition Notice recognizes that behavioral biases can influence substitution patterns and should be considered in the analysis. This recognition, however, forces a critical question: does incorporating behavioral biases lead to a more accurate and nuanced market definition, or does it risk making the analysis even more arbitrary and subjective? Introducing complex, often context-dependent, psychological factors could lead to less predictable outcomes. Therefore, as we move forward, it is imperative to examine how behavioral biases affect market definition—not with a simple assumption that their inclusion is an inherent improvement, but to rigorously test whether they can be integrated into a framework that enhances accuracy without sacrificing the consistency and objectivity vital to the rule of law.
Deconstructing Mental Accounting and Budget Framing
Fundamentally, mental accounting—a notion pioneered by Nobel laureate Richard Thaler—is the human tendency to classify and manage money differently depending on its source or planned use. Contrary to the traditional economic theory of fungibility—where a dollar is a dollar no matter its origin—people create unique “mental accounts” for their expenditures for things like groceries, amusement, or housing. This division of money results in self-imposed budget restrictions for every category, which makes customers hesitant to transfer money across these accounts even if doing so would be financially sensible.
This division serves as a cognitive short cut as well as a self-control system to help one to simplify challenging financial management. Therefore, money becomes non-fungible; people are very hesitant to move money over these self-imposed budget barriers. A family that runs out of its monthly “gasoline budget” would be hesitant to delve into its “grocery budget”, even if it is the most sensible choice. The competitive challenge arises not because these offerings are functionally dissimilar, but because, once consumers have fixed their mental budgets, they simply do not consider them as viable alternatives.
This is where the distinction from classical theory becomes critical. Mental budgeting can lead to both broader and narrower market definitions than traditional substitution models would suggest. When consumers are confronted with a price shock, the influence of these mental budgets becomes obvious. The landmark 2013 study on gasoline purchases by Hastings and Shapiro provides a powerful real-world example. They looked at how families reacted to a major rise in gas prices. Traditional economic theory holds that such a price increase is akin to a loss of income; hence, consumers should react by lowering costs across several categories. Consumers instead saw the price hike as a strain mainly on their “gas budget” and searched for answers inside that area instead of reducing on food or entertainment.
The behavioral finding is how this reaction differed from a standard income effect. The study found that an equivalent drop in total income did not generate the same sharp shift in gasoline grade. This proves the mental budget itself drove the behavior. Consumers siloed the price shock only to their gas budget and refused to pull from their food budget, whereas a rational consumer would have treated it as a simple income loss and cut back proportionally from all categories. This caused a huge intra-category substitution as drivers mostly changed from buying premium-grade fuel to less expensive, regular-grade gasoline. Critically, an equivalent drop in total income did not generate the same noticeable change in gasoline grade selection, showing that the mental accounting for a behavior was driven by a particular product category.
Heath and Solls’ 1996 classic work showed that when people overspend or encounter an unanticipated expense in one area, their corrective behavior is concentrated overly on the same group of goods. For example, participants who imagine paying for an expensive, unscheduled meal (and thus overspending their budget) usually report that they would compensate by cutting out a future movie or dinner. Nevertheless, they don’t declare a similar plan to cut down on groceries or clothes. This data suggests a main consideration for market definition: goods falling under different mental budgets may exert little competitive pressure on one another, even when they are functionally related.
A clearer example is the groceries budget versus the restaurant budget. Both provide the same functional purpose: a meal. Yet a rigid mental budget often blocks substitution. If a favorite restaurant raises prices, the consumer may not switch to a cheaper, functionally similar home-cooked meal from the grocery budget. Instead, they look only for substitutes within the restaurant budget, such as fast food. This mental wall keeps these functionally substitutable products from competing directly.
Recent theoretical models have also shown how mental budgeting can actually broaden relevant markets. Arguing that consumers use broad budgets as an ideal strategy to deal with complexity, Kőszegi and Matějka (2020) create a theory of “choice simplification.” A household might establish an “entertainment budget” and treat streaming, movies, gaming, and concerts as direct substitutes fighting for the same pool rather than evaluating each choice independently. These models propose that mental accounting may widen the borders of competition since markets are determined also by the more general budgetary divisions under which customers organize several products. Moreover, when making big purchases, customers often set a maximum spending limit (like “no more than $1,000 on a mattress”). This limit frames all mattresses below that price as rivals and automatically excludes only the more expensive ones. This could contribute to narrower market definitions.
Another consideration is that mental accounting affects smaller, less obvious events that still cause people to switch choices. For instance, how payment is framed greatly influences purchasing decisions. Consumers often prefer paying for an add-on or subscription as a small, regular monthly cost instead of a large lump sum. Although preferring to pay later may resemble the classic time value of money, behavioral models explain it through mental accounting.
Consumers divide money into accounts like current income and current assets and treat them as non-fungible. The behavioral life-cycle hypothesis holds that spending is easiest from current income and harder from current assets. Mental accounting interacts with self-control motives, as described in the hypothesis. A small monthly subscription is framed as a minor current income expense, while a lump-sum payment is seen as drawing from current assets, creating a psychological disutility penalty. Thus, consumers prefer monthly payments not simply because they are delayed, but because this framing avoids the psychological cost of spending from an account “labeled” as wealth.
Additionally, studies on “windfall” income—like a work bonus or a small lottery win— show that this money is often treated separately. Mental accounting encourages people to use this money for pleasure or luxury items, which they usually can’t afford with a tight budget. This behavior is irrational from a classical economic view because it violates the principle of fungibility. A dollar should be the same regardless of its source. The market implication is that windfall income creates a temporary, separate splurge market. A $500 luxury item may not compete with a $500 home appliance from the savings budget, but it does compete with a weekend trip or concert tickets from the windfall budget.
Lessons for Enforcement: the Collision of Behavioral Science and Antitrust Law
Competition authorities have traditionally employed the Small but Significant and Non-transitory Increase in Price (SSNIP) test to define relevant markets. This test assesses whether a hypothetical monopolist of a product could profitably impose a small but significant price increase. If enough consumers switch to other products to make the price rise unprofitable, those substitute products are considered to be in the same market. While the SSNIP test remains a tool, behavioral economics provides a richer lens through which to interpret its results. The key insight is that the test measures how consumers respond to price changes, not why.
Understanding the “why” could also be valuable for enforcement, as it might suggest a different range of potential remedies. For instance, if the issue is behavioral inertia rather than a true lack of substitutes, choice architecture remedies might be considered as a more appropriate alternative, or at least complement, to traditional structural interventions.
Although the SSNIP test is usually used to give empirical objectivity to market definition, it has a severe knowledge issue. Regulators must forecast complex consumer behavior with imperfect data, creating an illusion of accuracy that hides significant ambiguity. The SSNIP test therefore cannot differentiate between a true lack of substitutes and just consumer inertia or status quo prejudice. However, SSNIP remains valuable because it provides a consistent, legally predictable baseline before incorporating behavioral refinements. Regulators can and should still start with the SSNIP data. Still, where that data shows weak substitution, behavioral insights can help determine if that weakness is due to genuine market power or consumer inertia.
If one ignores why the data looks the way it does, one risks misinterpreting these behavioral issues as evidence of market power, which creates a biased and incorrect view of the competitive environment. The reverse risk also exists. A purely classical analysis may define an overly broad market and miss market power if, in practice, consumers rarely substitute across products because of mental budgets, inertia, or framing.
The growing awareness of these consumer behaviors is causing a major, yet subtle, change in how competition authorities work globally. While they haven’t entirely revised their market definition methods, they realize that a more detailed grasp of consumer psychology is essential for accurate market analysis. The European Commission, in its revised notice on market definition, has acknowledged the need to consider non-price elements of competition, which are often influenced by behavioral factors. Officials have indicated they are taking a wider view of consumer welfare to include non-price factors. These are areas where consumer behavior (biases) can have a major impact. Possible tools for capturing behavioral biases include targeted consumer surveys, experiments that vary framing or defaults, and analysis of real-world data showing how small design changes affect switching. These approaches can help reveal whether limited substitution reflects true product differences or behavioral frictions.
Conclusion
Mental accounting and budget framing create conflicting forces in market definition. When consumers rigidly “silo” expenses, markets may seem smaller than they truly are, which gives sellers a small area of monopoly power. Conversely, when consumers combine different goods under a single budget (like an entertainment allowance for gaming, streaming, and movies), they easily switch between these options. This substitution creates a broader market than traditional tests would recognize. Both scenarios show the same thing: how consumers mentally organize their spending is just as important as how similar the products actually are.
These dynamics show how fragile market definition is as an enforcement benchmark. If market boundaries change based on how consumers mentally label and frame costs, then drawing clear, fixed lines is inherently unstable. Market definition risks being either too broad or too narrow depending on which consumer behavior is strongest, and no single test can account for this. This suggests enforcers shouldn’t treat market definition as a scientific truth; its, at best, a practical stand-in. Behavioral insights clarify the situation, but they also highlight that competition is fluid and complex.
