# Bounded Rationality in Markets (1) - PowerPoint PPT Presentation

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Bounded Rationality in Markets (1). Bounded Rationality in Markets (2). Example: Design of Distribution Contract. Manufacturer. C = 2. W (Integrated)?. Retailer. Price(Integrated)?. Demand = 10 - price. Integrated versus Independent Channels. Integrated Independent. Manufacturer.

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Bounded Rationality in Markets (1)

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Bounded Rationality in Markets (1)

AMA Doctoral Consortium

Bounded Rationality in Markets (2)

AMA Doctoral Consortium

Example: Design of Distribution Contract

AMA Doctoral Consortium

Manufacturer

C = 2

W (Integrated)?

Retailer

Price(Integrated)?

Demand = 10 - price

### Integrated versus Independent Channels

Integrated Independent

Manufacturer

C = 2

W (Independent) ?

Retailer

Price(Independent) ?

Demand = 10 - price

AMA Doctoral Consortium

### Double Marginalization Problem

• Price (Integrated) = 6 < Price (Independent) = 8

• Total Profit (Integrated) = 16 > Total Profit (Independent) = 12

Manufacturer

C = 2

Manufacturer

C = 2

W (Integrated) = 2

W (Independent) = 6

Retailer

Retailer

Price(Independent) = 8

Price(Integrated) = 6

Demand = 10 - Price

Demand = 10 - Price

AMA Doctoral Consortium

### Solution to Double Marginalization Problem: Two-Part Tariff (TPT)

• Price (TPT) = Price (Integrated) = 6 < Price (Independent) = 8

• Total Profit (Integrated) = Total Profit (TPT) = 16 > Total Profit (Independent) = 12

Manufacturer

C= 2

Manufacturer

C = 2

F, W (TPT) = 2

W (Independent) = 6

Retailer

Retailer

Price (TPT) = 6

Price(Independent) = 8

Demand = 10 - Price

Demand = 10 - Price

AMA Doctoral Consortium

Standard Theory and Experimental Results

Significant Differences

No Difference

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Loss Aversion and Mental Accounting

• Up-front payment (F) and variable payment (w x Demand) are kept in two separate mental accounts.

• F is a loss that is incurred before any sales is realized and at the point where the reference profit is zero.

• Variable payment is incurred only after each unit of sales is realized.

• \$1 of up-front payment is equivalent to \$X of variable payment

• The value of \$X that maximizes the likelihood of observing the data turns out to be \$X =1.5

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Theory with Loss Aversion and Experimental Results

No Difference

No Difference

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Necessary Conditions for Generalization to Games and Markets

• Simple and precise alternative

• Can be used as a productive tool to generate testable hypotheses in different settings

• Explains behaviors better in existing settings

• Generate interesting predictions in new market settings

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Key Takeaways

• This emerging perspective spans traditional boundaries between consumer behavior (CB) and modeling (i.e., psychology and economics)

• The goal is help you to answer the question "are you a CB person or a modeler?” with "both!"

AMA Doctoral Consortium