The influence of reference effect on pricing strategies in revenue management settings

Abstract

This paper studies the reference effect on dynamic pricing in revenue management for cases with limited capacity and stochastic demand. We first present a single-period fixed pricing (FP) model in finite horizon with fixed capacity and stochastic demand, and show that there is a unique optimal solution. The model is then extended to a discrete-time dynamic pricing (DP) model as a benchmark case. We subsequently propose a DP model with reference effect (DPR), investigate the properties of the revenue function, and present a computational scheme to compute the dynamic optimal price. Numerical experiments are conducted to exhibit how the reference effect may influence the initial price, pricing trend, price dispersion, and expected revenue, with the FP, DP, and DPR policies in the same environment of a fixed capacity facing stochastic demand. We also present, through numerical examples, a comparison between deterministic demand and stochastic demand scenarios under reference effect, and with a fixed initial price versus a variable initial price.