Price Competition and Cost Efficiency Facing Buyer's

41 Pages Posted: 1 Jun 2022

See all articles by Sha Luo

Sha Luo

affiliation not provided to SSRN

Jiahua Zhang

Dongbei University of Finance & Economics

Shu-Cherng Fang

North Carolina State University

Russell E. King

affiliation not provided to SSRN

Abstract

This paper studies a pricing game in which two sellers compete to sell a product to a customer with bounded rationality. The sellers have different production costs in determining their respective prices to offer to the buyer. The buyer prefers the seller offering a lower price, but may suffer from some behavioral noises, such as bias, peer pressure and incapability, that lead the buyer to choose the seller offering a higher price with certain probability. In this sense, the buyer’s choice under bounded rationality is characterized in a probabilistic model. We find that if the buyer is mildly affected by bounded rationality, the seller with a lower production cost will lower the price to increase the probability to be chosen, but will increase the price for a better profit margin as the bounded rationality level increases. On the contrary, the seller with a higher production cost always enhances the price facing the buyer’s bounded rationality. Buyer’s bounded rationality is a driving factor for sellers’ price dispersion. Interestingly, we show that the bounded rationality, traditionally viewed as a performance-degrading impediment, may potentially lead to an unexpectedly higher payoff for the buyer. However, buyer’s bounded rationality is always detrimental to the social welfare as a whole. We also extend the results to the case with multiple sellers and show that the sellers will ask for even lower prices when the buyer has an outside option.

Keywords: pricing, Bounded rationality, competition, Salience, Exploitation

Suggested Citation

Luo, Sha and Zhang, Jiahua and Fang, Shu-Cherng and King, Russell E., Price Competition and Cost Efficiency Facing Buyer's. Available at SSRN: https://ssrn.com/abstract=4125395 or http://dx.doi.org/10.2139/ssrn.4125395

Sha Luo

affiliation not provided to SSRN ( email )

No Address Available

Jiahua Zhang (Contact Author)

Dongbei University of Finance & Economics ( email )

Dalian
China

Shu-Cherng Fang

North Carolina State University ( email )

Russell E. King

affiliation not provided to SSRN ( email )

No Address Available

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