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Reference dependence and market competition

Zhou, J.; (2008) Reference dependence and market competition. (Munich Personal RePEc Archive Series 9370). Munich University Library: Munich, Germany.

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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.

Type: Working / discussion paper
Title: Reference dependence and market competition
Publisher version: http://mpra.ub.uni-muenchen.de/9370/
Language: English
Additional information: Please see http://eprints.ucl.ac.uk/18669/ for the ELSE working paper version
Keywords: Advertising, competition, loss aversion, product quality, reference dependence
UCL classification: UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of SandHS > Dept of Economics
URI: http://discovery.ucl.ac.uk/id/eprint/17504
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