Reference Dependence and Market Competition
AbstractThis 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 InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 9370.
Date of creation: May 2008
Date of revision:
Other versions of this item:
- D11 - Microeconomics - - Household Behavior - - - Consumer Economics: Theory
- L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
- M37 - Business Administration and Business Economics; Marketing; Accounting - - Marketing and Advertising - - - Advertising
- D43 - Microeconomics - - Market Structure and Pricing - - - Oligopoly and Other Forms of Market Imperfection
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-07-05 (All new papers)
- NEP-BEC-2008-07-05 (Business Economics)
- NEP-COM-2008-07-05 (Industrial Competition)
- NEP-MIC-2008-07-05 (Microeconomics)
- NEP-MKT-2008-07-05 (Marketing)
- NEP-TID-2008-07-05 (Technology & Industrial Dynamics)
- NEP-UPT-2008-07-05 (Utility Models & Prospect Theory)
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