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Market-Based Solutions to Vital Economic Issues


Kenan Institute 2022 Annual Theme: Stakeholder Capitalism
Market-Based Solutions to Vital Economic Issues
Dec 3, 2018

Reference Dependence and Price Negotiations – The Role of Advertised Reference Prices


Retailers routinely indulge in comparative pricing where they post two different prices (e.g., regular price and sale or posted price) on the price tag of a product. Previous literature shows that comparing the posted price to a higher reference price, also known as the advertised reference price (ARP), increases consumer’s likelihood to purchase. In this paper, we study the effect of ARP on transacted prices (conditional on purchase) in settings where consumers can negotiate on prices. The effect of ARP on transacted prices is ambiguous and depends on how ARP influences transaction utility and a consumer’s beliefs about product prices and quality. Quantifying this effect is important to both, retailers and policy makers such as the Federal Trade Commission (FTC), which closely monitors deceptive pricing arising from price comparisons. Utilizing transactions data from a large durable goods retailer, we find that holding posted price fixed, a $1 increase in ARP results in a 10 cents increase in the transacted price. An increase in ARP lowers the likelihood to negotiate, but does not affect the transacted price conditional on negotiating. We explore the heterogeneity in the effect of ARP across salespeople, consumers, order and product characteristics, which as we discuss, has important managerial implications.

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