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Analyzing the effects of past prices on reference price formation

By R.D. van Oest and R. Paap


We propose a new reference price framework for brandchoice. In this framework, we employ a Markov-switching processwith an absorbing state to model unobserved price recall ofhouseholds. Reference prices result from the prices households areable to remember. Our model can be used to learn how many pricesobserved in the past are used for reference price formation.Furthermore, we learn to what extent households have sufficientprice knowledge to form an internal reference price. For A.C.Nielsen scanner panel data on catsup purchases, we find that theprices observed at the previous purchase occasion have an averagerecall probability of about 20%. Furthermore, the averageprobability that a household has sufficient price knowledge toform a reference price is estimated at about 30%. Even thoughprice recall is very limited the impact of reference priceformation on brand choice is substantial, and it is stronger thantwo popular alternative models in the literature suggest.Moreover, contrary to the two alternative models, our model doesnot suggest asymmetry between price gains and losses.brand choice;household scanner panel data;Markov switching process;reference price

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