Author's School

Olin Business School

Author's Department/Program

Business Administration

Language

English (en)

Date of Award

Spring 4-26-2013

Degree Type

Dissertation

Degree Name

Doctor of Philosophy (PhD)

Chair and Committee

Dmitri Kuksov

Abstract

It is well-known that consumers can deviate from the assumptions of standard economic theory in many ways. My dissertation examines the strategic implications of some behavioral anomalies of consumers in an equilibrium framework. In particular, I focus on how these behavioral anomalies could affect the optimal strategy and profitability of firms. The dissertation is comprised of two essays. In the first essay, I study the implications of consumer utility having a social component for competitive strategy of the firms and propose a model to explain the randomness of fashion hits observed in the fashion market. In the second essay, I investigate how firm pricing decision and profitability are affected by the presence of reference prices and consumer loss aversion.

The first essay looks at the fashion industry, where product demand is largely driven by consumers' desire to signal their social status through product usage, and theoretically explains why fashion hits appear to be randomly created. The fashion industry is characterized by its unpredictability and apparent randomness of fashion hits, i.e., no one is able to predict ahead of time which product will become the fashion statement about one's social status. In this essay, I consider fashion as a means consumers use to signal belonging to the high class and propose an analytical model of fashion hits in the presence of competition and consumers able to coordinate on which product to use. I show that consistently with the observed market phenomenon, in equilibrium, consumer coordination involves randomization between products chosen, i.e., in randomness of fashion hits. Analyzing optimal consumer choice, I derive that whenever low-type consumer demand for a product is positive, a price increase results in a higher probability of high-type consumers choosing this product but lower low-type consumer demand. I also show that although high-type consumers may prefer: higher) prices that would lead to complete separation of the high- and the low-type consumers through product use, in equilibrium, firms always price as to attract positive demand from low-type consumers. The equilibrium price and profits turn out to be non-monotone in the low-type consumer valuation of being recognized as belonging to the high class. Equilibrium profits first increase and then decrease in this valuation.

The second essay focuses on another consumer deviation from standard economic theory -- consumers evaluate prices relative to a reference point and exhibit loss aversion, i.e., consumer propensity to buy is more negatively affected by prices above the reference point than it is positively affected by prices below the reference point. Consumer loss aversion is a well-established phenomenon in marketing. The objective of this essay is to analytically examine how the competitive strategy and profitability are affected by the presence of consumer loss aversion. I develop a two-period model of competing firms and consumer search behavior affected by the reference price formed from past prices. While assuming that consumer loss aversion increases consumer propensity to search for lower prices, I find that it does not necessarily lead to lower prices and profits in a competitive environment. Specifically, consumer loss aversion could lead to higher prices and profits when consumer valuation is sufficiently high relative to their search costs and the proportion of consumers with positive search costs is in an intermediate range. I also show that even when forward-looking firms fully incorporate the negative effect of current price promotions on future profits, not only they still find promotional pricing optimal, but the optimal magnitude of promotions should not necessarily be reduced.

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Permanent URL: http://dx.doi.org/10.7936/K7W66HTM

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