Zhou, J.; (2009) Reference dependence and market competition. (ELSE Working Papers 341). ESRC Centre for Economic Learning and Social Evolution: London, UK.

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Abstract

This paper studies the implications of consumer reference dependence for market competition. If consumers take some product (e.g., the first product they consider) as the reference point when evaluating others and exhibit loss aversion, then the more “prominent” firm whose product is taken as the reference point by more consumers will randomize over a high and a low price. We also find that loss aversion in the price dimension intensifies the price competition while that in the product dimension softens the price competition. Consumer reference dependence can also shape firms’ advertising strategies. If advertising increases product prominence, ex ante identical firms may differentiate their advertising intensities and asymmetric prominence between firms can arise as an equilibrium outcome.

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