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Newsvendor Selling to Loss-Averse Consumers with Stochastic Reference Points

49 Pages Posted: 22 Sep 2013 Last revised: 23 Aug 2014

Opher Baron

University of Toronto - Operations Management

Ming Hu

University of Toronto - Rotman School of Management

Sami Najafi Asadolahi

Santa Clara University - Leavey School of Business

Qu Qian

Shanghai University of Finance and Economics - School of International Business Administration

Date Written: August 23, 2014

Abstract

Motivated by the supermarket practice of marking down perishable products daily, we study a newsvendor who sells a perishable asset over repeated periods to consumers with a given consumption valuation for the product. The market size in each period is random, following a stationary distribution. Consumers are loss averse with stochastic reference points that represent their beliefs about possible price and product availability. Given the distribution of reference points, they choose purchase plans to maximize their expected total utility, including gain-loss utility, before visiting the store and follow the plans in the store. In anticipation of consumers' purchase plans, in each period, before demand uncertainty resolves, the firm chooses an initial order quantity. After the uncertainty resolves, the firm chooses a contingent price depending on the demand realization, with the option of clearing inventory by charging a sale price, and otherwise, posting a full price. Over repeated periods, the interaction of the firm's operational decisions about ordering and contingent pricing and the consumers' purchase actions results in a distribution of reference points, and, in equilibrium, this distribution is consistent with consumers' beliefs. We fully characterize the firm's optimal inventory and contingent pricing policies. We identify conditions under which the firm's expected price and profit can be increasing in the consumer loss aversion level. We also show that the firm can prefer demand variability over no-demand uncertainty. We obtain a set of insights into how consumers' loss aversion affects the firm's optimal operational policies that are in stark contrast to those obtained in classic newsvendor models. As examples, the optimal full price increases in the initial order quantity, and the optimal full price decreases while the optimal sales frequency increases in the procurement cost.

Keywords: Newsvendor, Behavioral Operations, Loss Aversion, Contingent Pricing, Marketing Promotion, Stochastic Reference Points

Suggested Citation

Baron, Opher and Hu, Ming and Najafi Asadolahi, Sami and Qian, Qu, Newsvendor Selling to Loss-Averse Consumers with Stochastic Reference Points (August 23, 2014). Rotman School of Management Working Paper No. 2329242. Available at SSRN: https://ssrn.com/abstract=2329242 or http://dx.doi.org/10.2139/ssrn.2329242

Opher Baron

University of Toronto - Operations Management ( email )

105 St. George st
Toronto, ON M5S 3E6
Canada

Ming Hu (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George st
Toronto, ON M5S 3E6
Canada
416-946-5207 (Phone)

HOME PAGE: http://ming.hu

Sami Najafi Asadolahi

Santa Clara University - Leavey School of Business ( email )

500 El Camino Real
Santa Clara, CA California 95053
United States

Qu Qian

Shanghai University of Finance and Economics - School of International Business Administration ( email )

777 Guo-ding Road
Shanghai, 200433
China

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