Gurumurthy Kalyanaram, NYIT, former professor and Dean, reports on Prospect Theory and its application to Pricing.
Prospect theory (Kahneman&Tversky, 1979; Thaler, 1985) shows that consumers react sharply and adversely to perceived losses, and less favourably to perceived gains. This principle has found many business applications. For example, Barberis, Huang, and Santos (2001) show that investors react more sharply to losses in investment portfolio. There is asymmetric response to perceived fluctuations in wealth.
The asymmetric response has found wide applications in marketing, and particularly in pricing. Natarajan, Gurumurthy Kalyanaram, and Munch (2010) have shown such responses to new product announcements.
In the context of pricing, application of prospect theory suggests that consumers respond differently to prices above and below the reference prices: when an actual price is higher (lower) than the reference price, consumers consider it as a loss (gain).Literature reveals that consumers react more negatively to losses than they do positively to gains (Hardie et al., 1993; Kalwani et al., 1990; Mayhew &Winer, 1992; Putler, 1992). Krishnamurthi et al. (1992) studied the effect of reference price on purchase quantity decisions of consumers in regularly bought product items and found a significant effect of reference price. However, the effect is mediated by brand loyalty and household inventory levels. Mayhew and Winer (1992) show that consumers use internal reference points (“memory resident” price of the product) as well as external reference points (regular prices of the product) to evaluate product prices while making purchase decisions. Han, Gupta, and Lehmann (2001) and Pauwels, Srinivasan, and Franses (2007) also found asymmetric thresholds for price increases versus price decreases.
Please refer to other articles by Gurumurthy Kalyanaram NYIT, former professor and Dean on his website: www.gurumurthykalyanaram.com/nyit.html
Prospect theory (Kahneman&Tversky, 1979; Thaler, 1985) shows that consumers react sharply and adversely to perceived losses, and less favourably to perceived gains. This principle has found many business applications. For example, Barberis, Huang, and Santos (2001) show that investors react more sharply to losses in investment portfolio. There is asymmetric response to perceived fluctuations in wealth.
The asymmetric response has found wide applications in marketing, and particularly in pricing. Natarajan, Gurumurthy Kalyanaram, and Munch (2010) have shown such responses to new product announcements.
In the context of pricing, application of prospect theory suggests that consumers respond differently to prices above and below the reference prices: when an actual price is higher (lower) than the reference price, consumers consider it as a loss (gain).Literature reveals that consumers react more negatively to losses than they do positively to gains (Hardie et al., 1993; Kalwani et al., 1990; Mayhew &Winer, 1992; Putler, 1992). Krishnamurthi et al. (1992) studied the effect of reference price on purchase quantity decisions of consumers in regularly bought product items and found a significant effect of reference price. However, the effect is mediated by brand loyalty and household inventory levels. Mayhew and Winer (1992) show that consumers use internal reference points (“memory resident” price of the product) as well as external reference points (regular prices of the product) to evaluate product prices while making purchase decisions. Han, Gupta, and Lehmann (2001) and Pauwels, Srinivasan, and Franses (2007) also found asymmetric thresholds for price increases versus price decreases.
Please refer to other articles by Gurumurthy Kalyanaram NYIT, former professor and Dean on his website: www.gurumurthykalyanaram.com/nyit.html
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