Forward-looking Behavior Research Articles

Stability and chaos in demand-based pricing under social interactions

Demand-based pricing is often used to moderate demand fluctuations so as to level resource utilization and increase profitability. However, such pricing policies may not be effective when customers’ purchase decisions are influenced by social interactions. This paper investigates the demand dynamics, under a demand-based pricing policy, of a frequently purchased service when social interactions are at work. Customers are heterogeneous and adaptively forward-looking. Existing customers’ re-purchase decisions are based on adaptively formed price expectations and reservation prices. Potential customers are attracted through social interactions with existing customers. The demand process is characterized by a two-dimensional dynamical system. It is shown that the equilibrium demand can be unstable. For a given reservation price distribution, we first analyze the stability of the equilibrium demand under various scenarios of social interactions and customers’ adaptively forward-looking behavior, and then characterize their dynamics using the bifurcation plots, Lyapunov exponents and return maps. The results indicate that the demand process can be stable, periodic or chaotic. The study shows that the intended effect of a demand-based pricing policy may be offset by customers’ adaptively forward-looking behavior under the influence of social interactions. In fact, the interplay of these factors may even lead to chaotic demand dynamics. The result highlights the complex dynamics produced by a simple demand-price mechanism under social interactions. For a demand-based pricing strategy to be effective, companies must take social interactions into account.

Subjective Completion Beliefs and the Demand for Post-Secondary Education

The outcome of pursuing a post-secondary educational degree is uncertain. A student might not complete a chosen degree for a number of reasons, such as academic insufficiency or financial constraints. Thus, when considering whether to invest in post-secondary education, students must factor in their completion probability into their decision. We study the role of this uncertainty in educational choices using students’ subjective beliefs about completing a post-secondary education, which were elicited prior to students’ completing secondary education. We relate these subjective completion probabilities to their subsequent educational choices and outcomes using representative survey data from Germany. Following the students over time, we find that the initial beliefs are predictive of intentions to invest in education, actual subsequent educational investments, and degree completion. We assess the heterogeneity of the impact across different educational paths. After controlling for academic ability, we find that subjective beliefs are most relevant in choosing a vocational education. In addition to reduced form models, we estimate a structural choice model of sequential investment in education that allows for unobserved tastes and preferences for education and forward-looking behavior. The results confirm the influence of subjective completion beliefs on choosing a post-secondary education.

A Decision Support Framework for Optimal Pricing and Advertising of Digital Music as Durable Goods

With the recent rising popularity of music streaming platforms, consumers are now able to enjoy music as a service, playing music for free without paying to obtain the ownership, the threat to the record labels’ financial prospect is eminent. We propose a novel decision support framework to assist the record label in making better informed decisions in the postrelease management timeframe to maximise the expected profit. By identifying the musical product as a durable goods, we model the consumers’ consumption rule with forward-looking behaviour, viewing music streaming as the consumers’ option of delayed consumption, making purchase only when the expected discounted lifetime utility exceeds the expected utility from streaming. Our proposed decision support framework has the record label use both the price and advertising as instrument of control in achieving maximised expected discounted profit, playing strategically in anticipating to the consumers’ decisions using an interactive Markov chain. We show in our illustrative example the proposed decision support framework is able to make decisions dynamically and performs substantially better than other single control variable decision tools.

Rational Habits in Residential Electricity Demand

Dynamic partial adjustment models of residential electricity demand account for the fact that households may not adjust electricity consumption immediately in response to changes in prices, income, and other relevant factors, because of behavioral habits or adjustment costs for the capital stock of appliances. However, forward-looking behavior is generally neglected. Expectations about future prices or consumption may have an impact on current decisions. In this paper we propose rational habit models for residential electricity demand and apply them to a panel of 48 US states between 1995 and 2011. We estimate lead consumption models using fixed effects, instrumental variables, and the GMM Blundell-Bond estimator. We find that expectations about future consumption significantly influence current consumption decisions, which suggests that households behave rationally when making electricity consumption decisions. This novel approach may improve our understanding of the dynamics of residential electricity demand and the evaluation of the effects of energy policies.

Inter-Ethnic Fertility Spillovers and the Role of Forward-Looking Behavior: Evidence from Peninsular Malaysia

Demographic pressures can create competition for limited private and public resources and exacerbate pre-existing inter-ethnic tensions. At the same time, inter-ethnic competition may influence individual fertility decisions. Using the variation in birth rates in Malaysia induced by the Chinese lunar calendar, we document a 12.7-percent rise in births among ethnic Chinese in dragon years, which are considered auspicious. We find a negative fertility response from Malays – for every additional Chinese new-born child, Malays reduced their fertility by 0.30 children. We estimate the elasticity of this inter-ethnic fertility spillover (-0.15), and we find strongly suggestive evidence that pressure on resources was an important driver of these spillovers. The Malay response was greatest in areas where resources were more limited, and in areas with lower public investments. These results suggest that households are forward-looking in their fertility decisions, and they point to the potential role of governments in reducing ethnic tension through policies that increase private and public resources.

Green supply chain performance with cost learning and operational inefficiency effects

Environmental issues are receiving significant attention from the public, accelerating the development of green supply chain in operations management. This study focuses on the green supply chain performance in a single manufacturer-retailer setup, in which the manufacturer determines energy efficiency level and wholesale price, while the retailer decides on sales price. The unit production cost is jointly affected by cost learning and operational inefficiency effects. Open-loop, feedback and myopic equilibria are subsequently derived, and the corresponding supply chain performance and profit distribution are analyzed. The main results show that forward-looking behavior is preferred to myopic one for channel members. Feedback equilibrium is beneficial to the manufacturer, but is harmful to the retailer. The supply chain efficiencies in forward-looking and myopic situations are lower than the static supply chain efficiency, which results from cost learning and operational inefficiency effects, as well as non-price variable. The manufacturer and the retailer extract more profits under certain conditions, i.e., high cost learning effect, large energy efficiency effectiveness, low operational inefficiency effect or discount rate. However, the corresponding supply chain efficiencies decrease, and the manufacturer's profit proportions are less than 2/3. Investigation of supply chain performance with competition from multiple retailers implies that the effects of system parameters on supply chain performance keep the same directions of single manufacturer-retailer setup, while competition improves supply chain efficiency and manufacturer's profit proportion. This work contributes in involving cost learning and operational inefficiency effects simultaneously in a dynamic environment to explore supply chain performance.

Analyzing COPOM’s Decisions

This paper aims at modeling the conduct policy of the interest rate by the Monetary Policy Committee of the Central Bank of Brazil (COPOM), following methodologically a statistical framework developed by Engle & Russel (1998) and used by Hamilton & Jorda (2002) in studying the decisions of the Federal Reserve of the United States. The results, once we observe the period from January 2002 to July 2010 with a weekly frequency, suggest that COPOM is influenced by government expenditures and that it has a forward-looking behavior, holding onto the expectations of the Gross Domestic Product (GDP) and the official inflation of the country. In addition to this relevant evidence in the discussion of the balance between fiscal and monetary policies in Brazil, Brazilian monetary authority theoretically possesses a behavior which is aligned to that observed in practice, though it presents a greater sensitivity to macroeconomic variations.

Interdependences between current choices and future expectations in the context of Hanoians’ residential location choices

ABSTRACTBased on the theory of backward-looking and forward-looking behaviour, a residential location choice model is established to represent interdependences between current choices and future expectations (FE). The interdependences might be observed not only with respect to a particular alternative in a choice set (within-alternative interdependences), but also between different alternatives (between-alternative interdependences), which are jointly incorporated by using a paired combinatorial logit model. Analysis results using data collected from 13,712 individuals in Hanoi in 2005 confirmed that 26.42–55.28% of the total variance of current residential location choice utility can be explained by FE, while 40.81–99.37% of FE can be captured by current choices (i.e. state dependence). The influence of within-alternative interdependences regarding urban core (UC) residence for low-income individuals is almost double that for medium-to-high-income individuals. For between-alternative interdependences, similar results are observed for both low- and medium-to-high-income groups: it can explain 37.37–58.55% of total variance for suburban residence, but only marginal influence (0.00–0.89%) is confirmed for UC residence. These findings suggest that FE cannot be ignored in the analysis of residential location choice behaviour.

Identification of Dynamic Models of Rewards Program

'Frequent-buyer' type of rewards program is a commonly used marketing tool for companies to compete for market shares. It also provides an unique environment for studying consumer's forward-looking behavior. In particular, the consumer's problem can be formulated as a stationary infinite horizon discrete choice dynamic programming (DDP) model. We study the identification issue of this dynamic model of rewards program. To illustrate our identification arguments, we use a simple dynamic store choice model where stores offer 'frequent-buyer' type reward programs. We show that the parameters of this model, including the discount factor, are well-identified. We also discuss the connection between our model and the goal-gradient hypothesis proposed in the psychology literature.

Nominating Commissions, Judicial Retention, and Forward-Looking Behavior on State Supreme Courts: An Empirical Examination of Selection and Retention Methods

AbstractHigh-profile advocates are pushing states to move away from judicial elections and toward a “merit” method because it purportedly produces the best quality judges. Quality, however, is difficult to measure empirically. Rather than attempt to measure quality, we examine whether certain types of state supreme courts are more forward-looking than others. States are likely to desire forward-looking behavior among judges because it can protect judicial legitimacy, help states to control policy, and could be more efficient than myopic behavior. Using a recent innovation in matching called covariate-balancing propensity scores, we find that the U.S. Supreme Court is equally likely to review and reverse decisions by judges regardless of their selection or retention methods. These results suggest that state supreme court justices, no matter their paths of getting to (and staying on) their courts, are roughly equal in terms of forward-looking behavior.

Identification and Estimation of Forward-Looking Behavior: The Case of Consumer Stockpiling

We develop a new empirical strategy for identifying discount factors in markets for storable goods. The identification strategy rests on an exclusion restriction generated by discontinuities in package sizes: In storable goods product categories where consumption rates are exogenous and package sizes are discrete, current utility does not depend on inventory unless a package gets used up. Most of the time, inventory only enters a consumer's expected future value. We demonstrate using artificial data experiments that discount factors can be identified in these circumstances. We also demonstrate the feasibility of our identification strategy with an empirical exercise, where we estimate a stockpiling model using scanner data on laundry detergents. Preliminary estimates suggest that consumers are not as forward-looking as most papers in the literature assumes, with weekly discount factors averaging at about 0.91, which is significantly lower than the value used in previous research (it typically is set at 0.99, using the market interest rate).

Aspiration Failure: A Poverty Trap for Indigenous Children in Peru?

This paper aims to contribute to understand the mechanisms underlying the complex exclusion process of indigenous people in Peru, by analysing the role played by aspirations in the investment in education of indigenous children. To address these issues, the paper relies on a very rich data set, the Young Lives data, and use an original instrument that allow to cast light on the causal relation between aspiration and educational outcomes. We find that aspiration failure is a channel of inequality persistence between indigenous and non-indigenous people, but that aspiration failure do not takes the form of a lack of aspiration. Indigenous children do not have internalized racial schemas about occupation or about their opportunities. However, the gap between their aspiration and their current socio-economic status is too large, in so far as it has a disincentive effect on forward-looking behaviour.

Trade-in Remanufacturing, Customer Purchasing Behavior, and Government Policy

Trade-in remanufacturing is a commonly adopted business practice under which firms collect used products for remanufacturing by allowing repeat customers to trade in used products for upgraded ones at a discount price. This paper studies how customer purchasing behavior and remanufacturing efficiency affect the economic and environmental values of such a business practice. We demonstrate a new benefit of trade-in remanufacturing: it helps exploit the forward-looking behavior of strategic customers, which could be much more significant than the widely recognized revenue-generating and environmental benefits of remanufacturing. High remanufacturing efficiency does not necessarily benefit a firm. With overly high remanufacturing efficiency, product durability is so high that repeat customers are reluctant to trade in and upgrade their used products. When customers are highly strategic, trade-in remanufacturing creates a tension between profitability and sustainability: on one hand, by exploiting the intensive forward-looking customer behavior, trade-in remanufacturing is quite valuable to the firm; on the other hand, with highly strategic customers, trade-in remanufacturing has a substantial negative impact on the environment and social welfare, since it may induce significantly higher production quantities without improving customer surplus. With nearly myopic customers, however, trade-in remanufacturing benefits both the firm and the environment. Therefore, understanding the interactions between customer purchasing behavior and trade-in remanufacturing is important to both firms and policy makers. Finally, to resolve the above tension, we study how a social planner (e.g., government) should design a public policy to maximize social welfare. The social optimum can be achieved by using a simple linear subsidy/tax scheme for both new production and remanufacturing. The proposed policy can also induce the firm to set the socially optimal remanufacturing efficiency. The online appendix is available at https://doi.org/10.1287/msom.2017.0696 .

Good Things Come to Those Who (are Taught How to) Wait: Results from a Randomized Educational Intervention on Time Preference

We report results from the impact evaluation of a randomized educational intervention targeted at elementary school children. The program uses case studies, stories and classroom activities to improve the ability to imagine future selves, and emphasizes forward-looking behavior. We find that treated students make more patient intertemporal choices in incentivized experimental tasks. The effect is stronger for students who are identified as present-biased in the baseline. Furthermore, using official administrative records, we find that treated children are significantly less likely to receive a low “behavioral grade”. These results are persistent one year after the intervention, replicate well in a different sample, and are robust across different experimental elicitation methods.

Will Video Kill the Radio Star? Assessing the Potential of Targeted Exposure to Role Models through Video: Table 1:

In this paper, we focus on the effectiveness of video-based interventions in inducing behavioural changes in poor countries. We first review relevant literature from different disciplines. This suggests both that information targeted to an individual’s specific needs is more effective than broader messages and that videos featuring role models similar to viewers reinforce persuasiveness as the latter relate to the character. We then discuss some of the challenges in designing non-laboratory randomized controlled trials to evaluate video-based interventions. We draw on our design of a recently completed study in remote rural Ethiopia, which showed that simple documentaries of relatively successful individuals from the same region affected both viewers’ investment in their children’s education and other future-oriented behaviors (Bernard, T., S. Dercon, K. Orkin, and A. S. Taffesse. 2014. The Future in Mind: Aspirations and Forward-Looking Behaviour in Rural Ethiopia. Paper presented at Centre for the Study of African Economies conference on economic development in Africa, Oxford, UK, March 25). We discuss the importance and challenges of placebo treatments to evaluate the effects of exposure to video and gatherings, explore the potential for controlling variation in the exposure of an individual’s network of friends to the same treatment, and discuss external validity. Our experiment only partially addresses the issues we highlight, so we suggest directions for future research.

The Future in Mind: Aspirations and Forward-Looking Behaviour in Rural Ethiopia

Poor people often do not make investments, even when returns are high. One possible explanation is that they have low aspirations and form mental models which ignore some options for investment. This paper reports on findings of an innovative experiment to test this in rural Ethiopia. Firstly, individuals were randomly invited to watch documentaries about people from similar communities who had succeeded in agriculture or small business, without help from government or NGOs. A placebo group watched an Ethiopian entertainment programme and a control group were simply surveyed. Secondly, the number of invitees was varied by village to assess the importance of peer effects in the formation of aspirations. Six months after the screening of the documentaries, aspirations had improved among treated individuals but did not change in the placebo or control groups. Effects were larger for those with higher aspirations at baseline. We also find evidence of treatment effects on savings and credit behaviour, children’s school enrolment and investments in children’s schooling, suggesting that changes in aspirations can translate into changes in forward-looking behaviour. There are also positive treatment effects on a set of related measures from psychology and sociology, including a measure of locus of control, which theory predicts should behave in similar ways to aspirations. We also find that peer effects result in further impact on educational spending and induce more work and less leisure. That a one-hour documentary shown six months earlier induces such actual behavioural change offers challenging and promising areas for further research and the design of poverty-related interventions.

Regulatory Capital Requirements and Capital Buffers: An Examination of the Australian Banking Sector

Using a unique but confidential database, this study examines the capital management practices of Australian banks under the Basel regulatory framework. We find evidence of a significantly negative relationship between the internally targeted capital buffers of banks and the state of the business cycle. This finding supports the view that the capital conservation buffer and countercyclical capital buffer under the Basel III rules are necessary reforms to address the tendency of banks to manage their capital buffers in a pro-cyclical fashion. However, we also find evidence of forward-looking behaviour by bank managers that is likely to dampen the impact of fluctuations in credit market conditions on their lending activities: Banks set higher capital targets when economic activity is gathering momentum and the demand for loanable funds is increasing.

Estimating Open Economy New Keynesian Phillips Curve for Korea

We estimate the open economy new Keynesian Philips curve (NKPC) to characterize the inflation dynamics of Korea. While recent studies show that the NKPC holds for the pre-currency crisis period, the empirical evidence is inconclusive for the post-crisis period. Has globalization increased the role of global factors relative to domestic factors? Can labor income share still serve as a good measure of real marginal cost following the structural break? To address these issues for the post-crisis period, we use two types of open NKPC: the relative prices model and the incomplete pass-through model. The estimation of both models indicates that the forward-looking behavior is important, and its role is reinforced in an open economy specification. Both NKPC models also show that the external factors are more relevant inflation drivers than the domestic factors.

VAR INTERPRETATIONS OF HAAVELMO’S MARKET MODEL OF CAPITAL AND INVESTMENT

In the paper attempts are made to integrate two parts of Trygve Haavelmo’s work: investment theory and dynamic econometric models of interrelated markets. Specifically, the duality in the representation of the capital service price and the capital quantity in relation to the investment price and quantity are brought to the forefront and confronted with elements from simultaneous equation modeling of vector autoregressive systems containing exogenous variables (VARX), using linear four-equation models. The role of the interest rate and the modeling of the expectation element in the capital service price and the capital’s retirement pattern, and their joint effect on the model’s investment quantity and price dynamics are discussed. Stability conditions are illustrated by examples. Extensions relaxing geometric decay and ways of accounting for forward-looking behavior, including rational expectations, are outlined. Some remarks on the theory-data confrontation of this kind of model are given.

Measuring the Impact of Competition on Pricing Behaviors in a Two-Sided Market

The impact of competition on pricing has been studied in the context of counterfactual merger analyses where expected optimal prices in a hypothetical monopoly are compared with observed prices in an oligopolistic market. Such analyses would typically assume static decision making by consumers and firms and thus have been applied mostly to data obtained from consumer packed goods such as cereal and soft drinks. However such static modeling approach is not suitable when decision makers are forward looking. When it comes to the markets for durable products with indirect network effects, consumer purchase decisions and firm pricing decisions are inherently dynamic as they take into account future states when making purchase and pricing decisions. Researchers need to take into account the dynamic aspects of decision making both in the consumer side and in the supplier side for such markets. Firms in a two-sided market typically subsidize one side of the market to exploit the indirect network effect. Such pricing behaviors would be more prevalent in competitive markets where firms would try to win over the battle for standard. While such qualitative expectation on the relationship between pricing behaviors and competitive structures could be easily formed, little empirical studies have measured the extent to which the distinct pricing structure in two-sided markets depends on the competitive structure of the market. This paper develops an empirical model to measure the impact of competition on optimal pricing of durable products under indirect network effects. In order to measure the impact of exogenously determined competition among firms on pricing, we compare the equilibrium prices in the observed oligopoly market to those in a hypothetical monopoly market. In computing the equilibrium prices, we account for the forward looking behaviors of consumers and supplier. We first estimate a demand function that accounts for consumers`` forward-looking behaviors and indirect network effects. And then, for the supply side, the pricing equation is obtained as an outcome of the Markov Perfect Nash Equilibrium in pricing. In doing so, we utilize numerical dynamic programming techniques. We apply our model to a data set obtained from the U.S. video game console market. The video game console market is considered a prototypical case of two-sidedmarkets in which the platform typically subsidizes one side of market to expand the installed base anticipating larger revenues in the other side of market resulting from the expanded installed base. The data consist of monthly observations of price, hardware unit sales and the number of compatible software titles for Sony PlayStation and Nintendo 64 from September 1996 to August 2002. Sony PlayStation was released to the market a year before Nintendo 64 was launched. We compute the expected equilibrium price path for Nintendo 64 and Playstation for both oligopoly and for monopoly. Our analysis reveals that the price level differs significantly between two competition structures. The merged monopoly is expected to set prices higher by 14.8% for Sony PlayStation and 21.8% for Nintendo 64 on average than the independent firms in an oligopoly would do. And such removal of competition would result in a reduction in consumer value by 43.1%. Higher prices are expected for the hypothetical monopoly because the merged firm does not need to engage in the battle for industry standard. This result is attributed to the distinct property of a two-sided market that competing firms tend to set low prices particularly at the initial period to attract consumers at the introductory stage and to reinforce their own networks and eventually finally to dominate the market.