Product Pricing when Demand Follows a Rule of Thumb
We analyze the strategic behavior of firms when demand is determined by a rule of thumb behavior of consumers. We assume consumer dynamics where individual consumers follow simple behavioral decision rules governed by imitation and habit as suggested in consumer research. On this basis, we investigate monopoly and competition between firms, described via an open-loop differential game which in this setting is equivalent to but analytically more convenient than a closed-loop system. We derive a Nash equilibrium and examine the influence of advertising. We show for the monopoly case that a reduction of the space of all price paths in time to the space of time-constant prices is sensible since the latter in general contains Nash equilibria. We prove that the equilibrium price of the weakest active firm tends to marginal cost as the number of (non-identical) firms grows. Our model is consistent with observed market behavior such as product life cycles.
|Date of creation:||Feb 2009|
|Contact details of provider:|| Postal: Bonn Graduate School of Economics, University of Bonn, Adenauerallee 24 - 26, 53113 Bonn, Germany|
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- Schlag, Karl H., 1998.
"Why Imitate, and If So, How?, : A Boundedly Rational Approach to Multi-armed Bandits,"
Journal of Economic Theory,
Elsevier, vol. 78(1), pages 130-156, January.
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- Schlag, Karl H., 1994. "Why Imitate, and if so, How? Exploring a Model of Social Evolution," Discussion Paper Serie B 296, University of Bonn, Germany.
- Karl H. Schlag, 1995. "Why Imitate, and if so, How? A Bounded Rational Approach to Multi-Armed Bandits," Discussion Paper Serie B 361, University of Bonn, Germany, revised Mar 1996.
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- Ellison, Glenn & Fudenberg, Drew, 1993. "Rules of Thumb for Social Learning," Scholarly Articles 3196332, Harvard University Department of Economics.
- Ellison, Glenn & Fudenberg, Drew, 1992. "Rules of Thumb for Social Learning," IDEI Working Papers 17, Institut d'Économie Industrielle (IDEI), Toulouse.
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- Dennis E. Smallwood & John Conlisk, 1979. "Product Quality in Markets Where Consumers are Imperfectly Informed," The Quarterly Journal of Economics, Oxford University Press, vol. 93(1), pages 1-23.
- Sandholm, William H., 2005. "Excess payoff dynamics and other well-behaved evolutionary dynamics," Journal of Economic Theory, Elsevier, vol. 124(2), pages 149-170, October.
- Abhijit V. Banerjee, 1992. "A Simple Model of Herd Behavior," The Quarterly Journal of Economics, Oxford University Press, vol. 107(3), pages 797-817. Full references (including those not matched with items on IDEAS)
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