Am I Getting a Good Deal? Reference-DependentDecision Making When the Reference Price Is Uncertain

Abstract

Models of consumer decision making commonly incorporate reference dependent preferences. In these models, the reference point is typically assumed to be known by the consumer. However, research on price recall and the reference formation process reveals that the reference price is often uncertain at the time of purchase. Reference price uncertainty creates ambiguity for the consumer about whether they are getting a good or bad deal. This paper develops a model of consumer choice in the presence of reference dependent preferences when the reference price is uncertain. Data from two empirical studies that vary the product category and order of the elicitation of reference prices show that the new model generally outperforms conventional discrete choice models that either ignore reference prices or treat reference prices as certain. The new model provides insights into the effect of reducing reference price uncertainty on consumer choice, and reveals that high uncertainty smoothes the kink in the demand curve that is present in traditional reference-price demand models.