Dynamic Pricing in the Presence of Social Externalities and Reference-Price Effect

Abstract

This paper considers the pricing of a new product in the face of sophisticated consumer behaviors. At the individual level, consumers are forward-looking, whereby they may wait strategically for better purchasing opportunities. Additionally, and in line with prospect theory, consumers might also look back to form a reference-price point with which they can compare the current price. Consumers are assumed to be loss averse where losses resonate more than gains. Moreover, we account for the role of social influences in the form of externalities in consumers’ adoption decision. We develop progressively different nested models to examine the impact of each behavior. Two types of pricing regimes, that is, preannounced and responsive pricing, are utilized where the firm commits to the price path from the outset in the former while it does not in the latter. We find that a penetration pricing strategy can be both strengthened or weakened by forward-looking consumer behavior depending on the underlying dynamics. Contrary to what has been found in the literature, we obtain that a preannounced pricing regime does not necessarily lead to a higher profit.

Keywords: Dynamic pricing, reference-price effect, social externalities, forward-looking behavior, loss aversion