Abstract
Abstract A firm that accounts for consumer behavior sets the selling price of a product considering the reference price of consumers. In the literature, a reference price is usually modeled as depending on past selling prices. That is, past selling prices implicitly constrain the current selling price of a product. In this article, the author explicitly measures this constraint with an optimal control framework. He works on the structural properties of a general demand function, which depends on both selling and reference prices. Analytical results prove the following claims. Adjusting reference prices effects increase the price elasticity of demand, the demand function becoming flatter. Thus, the reference price effect weakens the market power of the firm. Also, the reference price effect constitutes a main driver of the dynamics of the selling price. But contrary to intuition, selling price dynamics does not systematically imitate reference price dynamics.
Highlights
Standard economics, investigating optimal pricing strategies, assumes a rational consumer for whom the selling price is the sole relevant variable related to price
This paper accounts for consumer behavior by integrating reference prices, and it analyzes the dynamic pricing policy in this context
I study the determinants of a dynamic pricing policy for a monopolistic firm, when descriptive aspects of consumer behavior are considered
Summary
Standard economics, investigating optimal pricing strategies, assumes a rational consumer for whom the selling price is the sole relevant variable related to price. This paper accounts for consumer behavior by integrating reference prices, and it analyzes the dynamic pricing policy in this context. I study the determinants of a dynamic pricing policy for a monopolistic firm, when descriptive aspects of consumer behavior are considered. This article belongs to the formal behavioral literature on dynamic pricing in which demand evolves adaptively on the basis of the firm’s past prices (see the review of Chenavaz et al 2011). In contrast to previous research mainly focusing on the intertemporal equilibrium, this article is primarily interested in characterizing the explicit dynamics of the selling price along the optimal path. By integrating descriptive aspects of customer behavior, this paper offers a better understanding of a successful firm pricing policy. A firm ignoring behavioral implications of its pricing policy would charge inadequately for its products, losing profit
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