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Do Consumers Correctly Expect Price Reductions? Testing Dynamic Behavior

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  • P. FÉVRIER

    (Crest)

  • L. WILNER

    (Insee)

Abstract

The literature on both theoretical and empirical dynamics requires agents to solve complex dynamic programs, which assumes implicitly that agents are fully rational and have the most accurate expectations given their information set. We claim that this assumption is easily testable provided that market-level data on prices and purchases are available. Using data on albums exhibiting frequent episodes of promotions, we perform a test derived from the predictions of a simple demand model and find that consumers hold simple expectations on the timing of promotions: everything happens as if consumers were expecting a Markov price process. Our results are consistent with the idea that the rationality of consumers is bounded because of limited memory or limited capacity. These results have important implications in terms of demand estimation, firms' optimal pricing strategy and computation of the welfare.

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File URL: http://www.insee.fr/en/publications-et-services/docs_doc_travail/G2012-03.pdf
File Function: Document de travail de la DESE numéro G2012-03
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Bibliographic Info

Paper provided by Institut National de la Statistique et des Etudes Economiques, DESE in its series Documents de Travail de la DESE - Working Papers of the DESE with number g2012-03.

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Date of creation: 2012
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Handle: RePEc:crs:wpdeee:g2012-03

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Related research

Keywords: Testing expectations; dynamic behavior; sales; imperfect information; bounded rationality;

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  1. Nair, Harikesh, S., 2006. "Intertemporal Price Discrimination with Forward-Looking Consumers: Application to the US Market for Console Video-Games," Research Papers 1947, Stanford University, Graduate School of Business.
  2. Bajari, Patrick & Benkard, C. Lanier & Levin, Jonathan, 2007. "Estimating Dynamic Models of Imperfect Competition," Research Papers 1852r1, Stanford University, Graduate School of Business.
  3. Lovell, Michael C, 1986. "Tests of the Rational Expectations Hypothesis," American Economic Review, American Economic Association, vol. 76(1), pages 110-24, March.
  4. Victor Aguirregabiria & Pedro Mira, 2004. "Sequential Estimation of Dynamic Discrete Games," Industrial Organization 0406006, EconWPA.
  5. Sofronis Clerides & Pascal Courty, 2010. "Sales, Quantity Surcharge, and Consumer Inattention," Working Paper Series 32_10, The Rimini Centre for Economic Analysis.
  6. Susanna Esteban & Matthew Shum, 2007. "Durable-goods oligopoly with secondary markets: the case of automobiles," RAND Journal of Economics, RAND Corporation, vol. 38(2), pages 332-354, 06.
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