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Why suggest non-binding retail prices ?

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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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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  1. S. Rosenkranz, 2003. "Manufacturer's Suggested Retail Prices," Working Papers 03-05, Utrecht School of Economics.
  2. Jullien, Bruno & Rey, Patrick, 2000. "Resale Price Maintenance and Collusion," IDEI Working Papers 102, Institut d'Économie Industrielle (IDEI), Toulouse.
  3. 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.
  4. 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.
  5. Milgrom, Paul & Shannon, Chris, 1994. "Monotone Comparative Statics," Econometrica, Econometric Society, vol. 62(1), pages 157-80, January.
  6. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  7. Rosenkranz, Stephanie, 2003. "The Manufacturer's Suggested Retail Price," CEPR Discussion Papers 3954, C.E.P.R. Discussion Papers.
  8. 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.
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