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Reference Dependence and Market Competition

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  • Zhou, Jidong

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.

Suggested Citation

  • Zhou, Jidong, 2008. "Reference Dependence and Market Competition," MPRA Paper 9370, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:9370
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Heiko Karle & Georg Kirchsteiger & Martin Peitz, 2015. "Loss Aversion and Consumption Choice: Theory and Experimental Evidence," American Economic Journal: Microeconomics, American Economic Association, vol. 7(2), pages 101-120, May.
    2. Karle, Heiko & Peitz, Martin, 2017. "De-targeting: Advertising an assortment of products to loss-averse consumers," European Economic Review, Elsevier, vol. 95(C), pages 103-124.
    3. Michael Grubb, 2015. "Behavioral Consumers in Industrial Organization: An Overview," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 47(3), pages 247-258, November.
    4. Michael D. Grubb, 2015. "Behavioral Consumers in Industrial Organization," Boston College Working Papers in Economics 879, Boston College Department of Economics.
    5. Elizabeth Bailey, 2015. "Behavioral Economics and U.S. Antitrust Policy," Review of Industrial Organization, Springer;The Industrial Organization Society, vol. 47(3), pages 355-366, November.
    6. Sheu, Jiuh-Biing, 2014. "Airline ambidextrous competition under an emissions trading scheme – A reference-dependent behavioral perspective," Transportation Research Part B: Methodological, Elsevier, vol. 60(C), pages 115-145.
    7. Ahrens, Steffen & Pirschel, Inske & Snower, Dennis J., 2017. "A theory of price adjustment under loss aversion," Journal of Economic Behavior & Organization, Elsevier, vol. 134(C), pages 78-95.
    8. Armstrong, Mark & Chen, Yongmin, 2012. "Discount pricing," MPRA Paper 39074, University Library of Munich, Germany.
    9. Antonio Rosato, 2016. "Selling substitute goods to loss-averse consumers: limited availability, bargains, and rip-offs," RAND Journal of Economics, RAND Corporation, vol. 47(3), pages 709-733, August.
    10. Karle, Heiko & Peitz, Martin, 2010. "Pricing and Information Disclosure in Markets with Loss-Averse Consumers," CEPR Discussion Papers 7785, C.E.P.R. Discussion Papers.
    11. Simona Fabrizi & Steffen Lippert & Clemens Puppe & Stephanie Rosenkranz, 2010. "Suggested retail prices with downstream competition," Working Papers 1203, University of Otago, Department of Economics, revised Aug 2012.
    12. Fabrizi, Simona & Lippert, Steffen & Puppe, Clemens & Rosenkranz, Stephanie, 2016. "Manufacturer suggested retail prices, loss aversion and competition," Journal of Economic Psychology, Elsevier, vol. 53(C), pages 141-153.
    13. Courty, Pascal & Nasiry, Javad, 2015. "Loss Aversion and the Uniform Pricing Puzzle for Vertically Differentiated Products," CEPR Discussion Papers 10523, C.E.P.R. Discussion Papers.
    14. Heidhues, Paul & Koszegi, Botond, 2014. "Regular prices and sales," Theoretical Economics, Econometric Society, vol. 9(1), January.
    15. Huck, Steffen & Zhou, Jidong, 2011. "Consumer behavioural biases in competition: A survey," MPRA Paper 31794, University Library of Munich, Germany.

    More about this item

    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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