Summary
We expand on the work of Kahneman and Tversky and further develop the optimal pricing policy given a reference price that generates psychological effects. We suggest the possibility of the existence of an inter-temporal substitution effect, challenging the standard substitution effect which always points to a reverse relationship between current and future quantity demanded and price. The optimal pricing trajectories are developed for various possible interrelationships between the reference price and the actual price and their possible influence on customer behavior.
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Extract
Economics of Deals and Optimal Pricing Policy
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I. INTRODUCTIONThe literature concerning behavioral economics dates back almost thirty years with the publication of the ground breaking research of Kahneman and Tversky (1979). They showed that individuals tend to be swayed by psychological factors when deciding on a purchase of a good or service. In the intervening years much further research has been undertaken. Today we use the term "Framing Effect" (see also Tversky and Kahneman (1981)) to describe the fact that individuals' purchasing decisions are often sharply influenced by the wording of the seller's offer although the different formulations of the offer are in effect completely identical. In other words, re-wording the exact same offer or deal could change the decision as to a purchase or as to accepting a certain level of risk in undertaking a project or an investment.Another aspect of this interesting phenomenon was brought to light in papers by Simonson et al. (1994) and Raghnbir (1998) [followed by similar papers by her (2004)] in which give-aways are studied. The idea of the give-away is that when you purchase a unit of product A, a unit of product B is given to you free of charge. Raghnbir's results show that being exposed to this give-away brings about a decline in the price that customers are willing to pay for good B when good B is being sold under normal (non give-away) market conditions. Clearly ...See the full content of this document
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