Reference Dependence and Market Competition

Zhou, Jidong (2008): Reference Dependence and Market Competition.

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.

• Item Type: MPRA Paper
• Language: English
• Subjects: D - Microeconomics > D1 - Household Behavior and Family Economics > D11 - Consumer Economics: Theory; L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L13 - Oligopoly and Other Imperfect Markets; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M3 - Marketing and Advertising > M37 - Advertising; D - Microeconomics > D4 - Market Structure, Pricing, and Design > D43 - Oligopoly and Other Forms of Market Imperfection

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