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Reference Dependence and Market Competition

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  • Jidong Zhou

Abstract

This paper studies the implications of consumer reference dependence in market competition. If consumers take some product (e.g., the first product they have considered) as the reference point in evaluating others and exhibit loss aversion, then the more "prominent" firm whose product is taken as the reference point by more consumers will randomize its price over a high and a low one. All else equal, this firm will on average earn a larger market share and a higher profit than its rival. The welfare impact is that consumer reference dependence could harm firms and benefit consumers by intensifying price competition. Consumer reference dependence will also shape firms' advertising strategies and quality choices. If advertising increases product prominence, ex ante identical firms may differentiate their advertising intensities. If firms vary in their prominence, the less prominent firm might supply a lower-quality product even if improving quality is costless.

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Bibliographic Info

Article provided by Wiley Blackwell in its journal Journal of Economics & Management Strategy.

Volume (Year): 20 (2011)
Issue (Month): 4 (December)
Pages: 1073-1097

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Handle: RePEc:bla:jemstr:v:20:y:2011:i:4:p:1073-1097

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References

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  1. Daniel S. Putler, 1992. "Incorporating Reference Price Effects into a Theory of Consumer Choice," Marketing Science, INFORMS, vol. 11(3), pages 287-309.
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Citations

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Cited by:
  1. Ahrens, Steffen & Pirschel, Inske & Snower, Dennis J., 2014. "A theory of price adjustment under loss aversion," Economics Working Papers 2014-05, Christian-Albrechts-University of Kiel, Department of Economics.
  2. Huck, Steffen & Zhou, Jidong, 2011. "Consumer behavioural biases in competition: A survey," MPRA Paper 31794, University Library of Munich, Germany.
  3. Karle, Heiko & Kirchsteiger, Georg & Peitz, Martin, 2013. "Loss Aversion and Consumption Choice: Theory and Experimental Evidence," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79943, Verein für Socialpolitik / German Economic Association.
  4. Paul Heidhues & Botond Koszegi, 2010. "Regular prices and sales," ESMT Research Working Papers ESMT-10-008, ESMT European School of Management and Technology.
  5. Rosato, Antonio, 2013. "Selling Substitute Goods to Loss-Averse Consumers: Limited Availability, Bargains and Rip-offs," MPRA Paper 47168, University Library of Munich, Germany.
  6. Karle, Heiko & Peitz, Martin, 2010. "Pricing and Information Disclosure in Markets with Loss-Averse Consumers," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 312, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
  7. Armstrong, Mark & Chen, Yongmin, 2012. "Discount pricing," MPRA Paper 39074, University Library of Munich, Germany.
  8. Sheu, Jiuh-Biing, 2014. "Airline ambidextrous competition under an emissions trading scheme – A reference-dependent behavioral perspective," Transportation Research Part B: Methodological, Elsevier, vol. 60(C), pages 115-145.

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