Incorporating Reference Price Effects into a Theory of Consumer Choice

TLDR

Although research has examined reference‑price effects in empirical consumer‑buying models, formal theoretical work has been scarce. The study incorporates reference‑price effects into traditional consumer‑choice theory and examines their impact on theory, marketing implications, and empirical models of consumer behavior. The authors extend the standard consumer‑choice model to include reference‑price effects and empirically test the resulting implications with weekly retail egg‑sales data from Southern California. The analysis shows that reference‑price formation significantly affects consumer behavior, with consumers being 2.5 times more responsive to price increases above the reference price than to comparable decreases.

Abstract

Although there has been a good deal of research on incorporating the effects of reference price formation into empirical models of consumer buying behavior, little formal theoretical work had been undertaken to date. This paper incorporates reference price effects into the traditional economic theory of consumer choice, and examines the effects of reference price formation on the results of the traditional theory, its marketing implications, and the implications for empirical models which examine the effects of reference price formation on actual consumer behavior. Several implications of the theoretical model are empirically tested using weekly retail egg sales data from Southern California. This analysis indicates that reference price formation does have significant effects on consumer behavior. Furthermore, these effects are asymmetric with consumers two and a half times more responsive to egg price increases that are in excess of the reference price than they are to comparable egg price decreases.