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Why suggest non-binding retail prices ?

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  • C. Puppe
  • S. Rosenkranz

Abstract

We provide a simple behavioral explanation of why manufacturers frequently announce non-binding suggested retail prices for their products. Our model is based on the assumption that once the actual price for a product exceeds its suggested retail price, the marginal propensity to consume suddenly jumps downward. This property of individual demand corresponds to Kahneman and Tversky’s concept of loss aversion. We show that it may induce a monopolistic retailer to set the price equal to the suggested retail price in equilibrium, although the latter price is nonbinding. This, in turn, leads to a shift of profits from the retailer to the manufacturer.

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File URL: http://dspace.library.uu.nl/bitstream/handle/1874/37230/06-10.pdf
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Bibliographic Info

Paper provided by Utrecht School of Economics in its series Working Papers with number 06-10.

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Length: 21 pages
Date of creation: May 2006
Date of revision:
Handle: RePEc:use:tkiwps:0610

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Keywords: suggested retail prices; reference dependence; loss aversion;

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References

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  1. Frank Mathewson & Ralph Winter, 1998. "The Law and Economics of Resale Price Maintenance," Review of Industrial Organization, Springer, vol. 13(1), pages 57-84, April.
  2. B. Douglas Bernheim & Michael D. Whinston, 1985. "Common Marketing Agency as a Device for Facilitating Collusion," RAND Journal of Economics, The RAND Corporation, vol. 16(2), pages 269-281, Summer.
  3. Milgrom, P. & Shannon, C., 1991. "Monotone Comparative Statics," Papers 11, Stanford - Institute for Thoretical Economics.
  4. Bruno Jullien & Patrick Rey, 2007. "Resale price maintenance and collusion," RAND Journal of Economics, RAND Corporation, vol. 38(4), pages 983-1001, December.
  5. S. Rosenkranz, 2003. "The Manufacturer's Suggested Retail Price," Working Papers 03-05, Utrecht School of Economics.
  6. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-91, March.
  7. Tversky, Amos & Kahneman, Daniel, 1991. "Loss Aversion in Riskless Choice: A Reference-Dependent Model," The Quarterly Journal of Economics, MIT Press, vol. 106(4), pages 1039-61, November.
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Cited by:
  1. Stefan Buehler & Dennis L. Gäertner, 2013. "Making Sense of Nonbinding Retail-Price Recommendations," American Economic Review, American Economic Association, vol. 103(1), pages 335-59, February.
  2. Lisa Bruttel, 2014. "The Effects of Non-binding Retail-price Recommendations on Consumer and Retailer Behavior," TWI Research Paper Series 93, Thurgauer Wirtschaftsinstitut, Universität Konstanz.
  3. Armstrong, Mark & Chen, Yongmin, 2012. "Discount pricing," MPRA Paper 39074, University Library of Munich, Germany.
  4. Dmitry Lubensky, 2011. "A Model of Recommended Retail Prices," Working Papers 2011-06, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  5. Babur De los Santos & In Kyung Kim & Dmitry Lubensky, 2013. "Do MSRPs Decrease Prices?," Working Papers 2013-13, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.
  6. Dmitry Lubensky, 2013. "A Model of Recommended Retail Prices," Working Papers 2013-14, Indiana University, Kelley School of Business, Department of Business Economics and Public Policy.

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