Consumer price effects: Loss aversion in value vs. in demand

Abstract

It has been established that consumers are often loss averse in the sense that perceived value decreases to a greater extent as a result of a price increase than what it increases as a result of an equal price decrease. We examine a previously scarcely studied question: how is the change in a product’s perceived value following a price change reflected in the product’s market demand? To complement the notion of loss averse (vs. gain seeking) price behaviour in perceived value, we provide a definition for loss averse (vs. gain seeking) price behaviour in demand. We discover that loss aversion in value does not necessarily lead to loss averse market demand, but can also lead to market demand being gain-seeking. We examine the boundary conditions for loss averse vs. gain seeking demand. Assuming that consumer preferences are given by a random utility model and the choice model is McFadden’s conditional logit, we develop a simple formula to check the character of the price behaviour. This provides novel insights by revealing an unexpected key determinant: the market share of the product under consideration. Finally, we consider the optimal price changes and what kind of consumer behaviour in demand they are related to.

Keywords:

• Reference price
• loss aversion
• conditional logit
• brand choice

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

1 One might assume normal distribution instead of Gumbel distribution. In this case only numerical analysis is possible instead of the main result in (2).

2 The interpretation of the levels of value gain δ_L and loss δ_H relates to the standard deviation of the Gumbel distributed random variable ${ϵ}_i$ in the utility model (1). To obtain the conditional logit formula (2) from the utility function (1), the standard deviation of ${ϵ}_i$ is $\sigma =\pi /\sqrt{6}\approx 1.28.$ Hence, ${\delta }_L=.35$ refers to a value loss, which is about 27% of the standard deviation 1.28.