Consumer Choice and Market Outcomes Under Ambiguity in Product Quality

Facing purchase choice involving ambiguity in product quality, consumers behave in a boundedly rational manner. Consumers also exhibit varying degrees of predisposition toward a product. We present a simple model of boundedly rational choice under ambiguity. The model’s key feature is that it captures the interaction between predisposition and ambiguity. We build on the choice model to derive demand curves and the unique equilibrium market outcomes (regarding prices, profits, and market shares) under duopolistic competition. In equilibrium, market shares are proportional to prices. In symmetric competition, higher equilibrium prices obtain when the ambiguity in product quality is high or when the customer base is partisan. For vertically differentiated products, the strategy of a higher-quality firm to marginally reduce ambiguity depends on the ambiguity level inherent in the product–market environment. The presence of informed customers may increase the equilibrium prices and profits of both firms. An un...

[1]  Yuxin Chen,et al.  A Theory of Combative Advertising , 2009, Mark. Sci..

[2]  J. Miguel Villas-Boas,et al.  Optimal Search for Product Information , 2010, Manag. Sci..

[3]  Rakesh K. Sarin,et al.  Measurable Multiattribute Value Functions , 1979, Oper. Res..

[4]  J. Louviere,et al.  The impact of brand credibility on consumer price sensitivity , 2002 .

[5]  Dina Mayzlin,et al.  Promotional Chat on the Internet , 2006 .

[6]  George Loewenstein,et al.  The Creative Destruction of Decision Research , 2001 .

[7]  Daniel A. Ackerberg.  Empirically Distinguishing Informative and Prestige Effects of Advertising , 2001 .

[8]  H. Simon,et al.  A Behavioral Model of Rational Choice , 1955 .

[9]  Yubo Chen,et al.  Online Consumer Review: Word-of-Mouth as a New Element of Marketing Communication Mix , 2004, Manag. Sci..

[10]  Stephen J. Hoch,et al.  Ambiguity, Processing Strategy, and Advertising-Evidence Interactions , 1989 .

[11]  M. Johannesson,et al.  Characterizing QALYs by Risk Neutrality , 1997 .

[12]  Ramayya Krishnan,et al.  On Product-Level Uncertainty and Online Purchase Behavior: An Empirical Analysis , 2015, Manag. Sci..

[13]  K. Srinivasan,et al.  Signaling Quality with a Money-Back Guarantee: The Role of Transaction Costs , 1995 .

[14]  J. Klayman,et al.  Confirmation, Disconfirmation, and Informa-tion in Hypothesis Testing , 1987 .

[15]  Xinlei Chen,et al.  Informing, Transforming, and Persuading: Disentangling the Multiple Effects of Advertising on Brand Choice Decisions , 2008, Mark. Sci..

[16]  John Morgan,et al.  Brand and Price Advertising in Online Markets , 2004, Manag. Sci..

[17]  R. P. Nielsen.  Reason in human affairs, Herbert A. Simon, Stanford University Press, Stanford, 1983. No. of pages: 115. Price: $10.00 , 1985 .

[18]  Dmitri Kuksov,et al.  Information Provision in a Vertically Differentiated Competitive Marketplace , 2010, Mark. Sci..

[19]  Dominique M. Hanssens,et al.  Consumer Attitude Metrics for Guiding Marketing Mix Decisions , 2014, Mark. Sci..

[20]  D. Ellsberg.  Decision, probability, and utility: Risk, ambiguity, and the Savage axioms , 1961 .

[21]  M. Shi,et al.  Reward Programs and Tacit Collusion , 2001 .

[22]  Denis Bouyssou,et al.  Bounded Rationality Modeling , 1999 .

[23]  Colin Camerer,et al.  A Cognitive Hierarchy Model of Games , 2004 .

[24]  V. Srinivasan,et al.  A Survey-Based Method for Measuring and Understanding Brand Equity and Its Extendibility , 1994 .

[25]  J. Friedman.  Game theory with applications to economics , 1986 .

[26]  C. Sims.  Implications of rational inattention , 2003 .

[27]  C. Gettys,et al.  Hypothesis plausibility and hypothesis generation , 1979 .

[28]  Jiwoong Shin,et al.  Uninformative Advertising as an Invitation to Search , 2011, Mark. Sci..

[29]  Stephen J. Hoch,et al.  Consumer Learning: Advertising and the Ambiguity of Product Experience , 1986 .

[30]  Steven M. Shugan.  The Cost Of Thinking , 1980 .

[31]  J. M. Villas-Boas,et al.  The Targeting of Advertising , 2005 .

[32]  Gregory S. Crawford,et al.  Uncertainty and Learning in Pharmaceutical Demand , 2005 .

[33]  Yimin Yu,et al.  Sell Probabilistic Goods? A Behavioral Explanation for Opaque Selling , 2014, Mark. Sci..

[34]  B. Wernerfelt,et al.  Umbrella Branding as a Signal of New Product Quality: An Example of Signalling by Posting a Bond , 1988 .

[35]  A. Muthukrishnan.  Decision Ambiguity and Incumbent Brand Advantage , 1995 .

[36]  Yuxin Chen,et al.  Buyer-Initiated vs. Seller-Initiated Information Revelation , 2008, Manag. Sci..

[37]  A. Rao,et al.  No Pain, No Gain: A Critical Review of the Literature on Signaling Unobservable Product Quality , 2000 .

[38]  Pietro Ortoleva,et al.  The price of flexibility: Towards a theory of Thinking Aversion , 2013, J. Econ. Theory.

[39]  K. French,et al.  Investor Diversification and International Equity Markets , 1991 .

[40]  John D. C. Little,et al.  A Logit Model of Brand Choice Calibrated on Scanner Data , 2011, Mark. Sci..

[41]  Barry L. Bayus,et al.  Have diffusion rates been accelerating over time? , 1992 .

[42]  Harshinder Singh,et al.  The Reversed Hazard Rate Function , 1998, Probability in the Engineering and Informational Sciences.

[43]  K. Leffler.  Ambiguous Changes in Product Quality , 1982 .

[44]  J. Klayman.  Varieties of Confirmation Bias , 1995 .

[45]  Eitan Gerstner.  Do Higher Prices Signal Higher Quality? , 1985 .

[46]  Ganesh Iyer,et al.  Limited Memory, Categorization, and Competition , 2010, Mark. Sci..

[47]  David A. Soberman,et al.  Research Note: Additional Learning and Implications on the Role of Informative Advertising , 2004, Manag. Sci..

[48]  Jinhong Xie,et al.  Third-Party Product Review and Firm Marketing Strategy , 2005 .

[49]  H. Hotelling.  Stability in Competition , 1929 .

[50]  Daniel S. Kostyra,et al.  Decomposing the Effects of Online Customer Reviews on Brand, Price, and Product Attributes , 2015 .

[51]  D. Kahneman.  Maps of Bounded Rationality: Psychology for Behavioral Economics , 2003 .

[52]  Paul R. Milgrom,et al.  Price and Advertising Signals of Product Quality , 1986, Journal of Political Economy.

[53]  P. Klemperer.  Competition when Consumers have Switching Costs: An Overview with Applications to Industrial Organization, Macroeconomics, and International Trade , 1992 .

[54]  Colin Camerer.  Bounded Rationality in Individual Decision Making , 1998 .

[55]  William Samuelson,et al.  Status quo bias in decision making , 1988 .

[56]  C. Narasimhan.  Competitive Promotional Strategies , 1988 .

[57]  R. Rao.  Pricing and Promotions in Asymmetric Duopolies , 1991 .

[58]  Deepak Agrawal,et al.  Effect of Brand Loyalty on Advertising and Trade Promotions: A Game Theoretic Analysis with Empirical Evidence , 1996 .

[59]  J. Edward Russo,et al.  Information distortion in the evaluation of a single option , 2007 .

[60]  Henry G. Grabowski,et al.  Brand Loyalty, Entry, and Price Competition in Pharmaceuticals after the 1984 Drug Act , 1992, The Journal of Law and Economics.

[61]  P. Nelson.  Advertising as Information , 1974, Journal of Political Economy.

[62]  Bing Jing,et al.  Exogenous Learning, Seller-Induced Learning, and Marketing of Durable Goods , 2011, Manag. Sci..

[63]  Arthur B. Markman,et al.  Overcoming the Early Entrant Advantage: The Role of Alignable and Nonalignable Differences , 1998 .

[64]  Daniel C. Smith,et al.  The Effects of Brand Extensions on Market Share and Advertising Efficiency , 1992 .

[65]  B. Wernerfelt,et al.  Brand Loyalty and Market Equilibrium , 1991 .

[66]  Luc Wathieu,et al.  Price as a Stimulus to Think: The Case for Willful Overpricing , 2007 .

[67]  P. Danaher,et al.  A Comparison of Online and Offline Consumer Brand Loyalty , 2003 .

[68]  R. Pieters,et al.  Preference reversal for copycat brands: Uncertainty makes imitation feel good , 2013 .

[69]  Frank R. Kardes,et al.  Persistent Preferences for Product Attributes: The Effects of the Initial Choice Context and Uninformative Experience , 2001 .

[70]  E. Maskin,et al.  The Existence of Equilibrium in Discontinuous Economic Games, I: Theory , 1986 .

[71]  C. Shapiro,et al.  Informative Advertising with Differentiated Products , 1984 .

[72]  Todd Sarver,et al.  A Unique Costly Contemplation Representation , 2010 .

[73]  Jonathan Baron,et al.  Behavioral Law and Economics: Reluctance to Vaccinate: Omission Bias and Ambiguity , 1990 .

[74]  R. Lal,et al.  The Effects of Brand Loyalty on Competitive Price Promotional Strategies , 1990 .

[75]  H. S. Houthakker,et al.  Compensated Changes in Quantities and Qualities Consumed , 1952 .

[76]  Rakesh K. Sarin,et al.  Risk-value models , 1993 .

[77]  R. Nickerson.  Confirmation Bias: A Ubiquitous Phenomenon in Many Guises , 1998 .

[78]  F. Knight.  The economic nature of the firm: From Risk, Uncertainty, and Profit , 2009 .

[79]  Donald G. Morrison,et al.  Note---A Brand Switching Model with Implications for Marketing Strategies , 1989 .

[80]  Garett J. Longwell.  Managing brand equity: Capitalizing on the value of a brand name: David A. Aaker, The Free Press, New York (1991) , 1994 .

[81]  R. Thaler,et al.  Save More Tomorrow™: Using Behavioral Economics to Increase Employee Saving , 2004, Journal of Political Economy.

[82]  A. Tversky,et al.  Support theory: A nonextensional representation of subjective probability. , 1994 .

[83]  J. M. Villas-Boas.  Consumer Learning, Brand Loyalty, and Competition , 2004 .

[84]  L. Krishnamurthi,et al.  An Empirical Analysis of the Relationship Between Brand Loyalty and Consumer Price Elasticity , 1991 .

[85]  Monic Sun,et al.  How Does the Variance of Product Ratings Matter? , 2010, Manag. Sci..

[86]  A. V. Muthukrishnan,et al.  Ambiguity Aversion and the Preference for Established Brands , 2009, Manag. Sci..

[87]  John R. Hauser,et al.  Learning from Experience, Simply , 2014, Mark. Sci..

[88]  Bart J. Bronnenberg,et al.  Do Pharmacists Buy Bayer? Informed Shoppers and the Brand Premium , 2014 .

[89]  J. Deighton,et al.  The Effects of Advertising on Brand Switching and Repeat Purchasing , 1994 .

[90]  J. Keynes.  A Treatise on Probability. , 1923 .

[91]  G. Stigler.  The Economics of Information , 1961, Journal of Political Economy.