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Reference Dependence and Market Competition

Author Info

Listed author(s):
  • 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.

(This abstract was borrowed from another version of this item.)

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File URL: http://hdl.handle.net/10.1111/j.1530-9134.2011.00309.x
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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
DOI: j.1530-9134.2011.00309.x
Contact details of provider: Web page: http://www.kellogg.northwestern.edu/research/journals/JEMS/

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Find related papers by JEL classification:
  • 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; Personnel Economics - - Marketing and Advertising - - - Advertising
  • D43 - Microeconomics - - Market Structure, Pricing, and Design - - - Oligopoly and Other Forms of Market Imperfection

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  1. Xavier Gabaix & David Laibson, 2006. "Shrouded Attributes, Consumer Myopia, and Information Suppression in Competitive Markets," The Quarterly Journal of Economics, Oxford University Press, vol. 121(2), pages 505-540.
  2. Oliver Hart & John Moore, 2006. "Contracts as Reference Points," NBER Working Papers 12706, National Bureau of Economic Research, Inc.
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  8. Johnson, Eric J & Hershey, John & Meszaros, Jacqueline & Kunreuther, Howard, 1993. "Framing, Probability Distortions, and Insurance Decisions," Journal of Risk and Uncertainty, Springer, vol. 7(1), pages 35-51, August.
  9. Gadi Fibich & Arieh Gavious & Oded Lowengart, 2007. "Optimal price promotion in the presence of asymmetric reference-price effects," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 28(6), pages 569-577.
  10. Amos Tversky & Daniel Kahneman, 1991. "Loss Aversion in Riskless Choice: A Reference-Dependent Model," The Quarterly Journal of Economics, Oxford University Press, vol. 106(4), pages 1039-1061.
  11. Joel Sobel, 1984. "The Timing of Sales," Review of Economic Studies, Oxford University Press, vol. 51(3), pages 353-368.
  12. Rubinstein, Ariel, 1993. "On Price Recognition and Computational Complexity in a Monopolistic Model," Journal of Political Economy, University of Chicago Press, vol. 101(3), pages 473-484, June.
  13. Spiegler, Ran, 2006. "Competition over agents with boundedly rational expectations," Theoretical Economics, Econometric Society, vol. 1(2), pages 207-231, June.
  14. Avner Shaked & John Sutton, 1982. "Relaxing Price Competition Through Product Differentiation," Review of Economic Studies, Oxford University Press, vol. 49(1), pages 3-13.
  15. Matthew Rabin & Joel L. Schrag, 1999. "First Impressions Matter: A Model of Confirmatory Bias," The Quarterly Journal of Economics, Oxford University Press, vol. 114(1), pages 37-82.
  16. 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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