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Spring 2006 Seminar Series
MASSACHUSETTS INSTITUTE OF TECHNOLOGY
OPERATIONS RESEARCH CENTER
SPRING 2006 SEMINAR SERIES
DATE: Thursday, March 9, 2006
LOCATION: E40-298
TIME: 4:15pm
Reception immediately following in the Philip M. Morse Reading Room, E40-106
SPEAKER:
Ioana Popescu
Assistant Professor Decision Sciences
INSEAD
TITLE
Dynamic Pricing with Reference Effects
ABSTRACT
We consider the dynamic pricing problem of a monopolist firm in
a market with repeated interactions, where demand is sensitive
to the firm's pricing history. Consumers have memory and are prone
to human decision making biases and cognitive limitations. As the
firm manipulates prices, consumers form a reference price that
adjusts as an anchoring standard based on price perceptions.
Purchase decisions are made by assessing prices as discounts or
surcharges relative to the reference price, in the spirit of prospect
theory.
We prove that optimal pricing policies induce a perception of
monotonic prices, whereby consumers always perceive a discount,
respectively surcharge, relative to their expectations. The effect
is that of a skimming or penetration strategy. The firm's
optimal pricing path is monotonic on the long run, but not necessarily
at the introductory stage. If consumers are loss averse, we show
that optimal prices converge to a constant steady state price,
characterized by a simple implicit equation; otherwise the optimal
policy cycles. The range of steady states is wider the more loss
averse consumers are. Steady state prices decrease with the strength
of the reference effect, and with customers' memory, all else equal.
Offering lower prices to frequent customers may be suboptimal,
however, if these are less sensitive to price changes than occasional
buyers.
If managers ignore such long term implications of their pricing
strategy, the model indicates that they will systematically price
too low and lose revenue. Our results hold under very general reference
dependent demand models.
Joint work with Yaozhong Wu (INSEAD).
Paper at http://faculty.insead.edu/popescu/ioana/Papers/PopescuWu.pdf
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