A two-period pricing model with customers' reference prices

Abstract

This paper studies the two-period pricing model considering customers' reference prices. We assume that customers respond to the current price of a product by comparing it to the past prices and this response will lead to reference effect. By solving a two-stage dynamic programming problem, we provide the optimal price policy for the seller. The numerical example shows that the optimal price for either period and the gross profit are decreasing with the increase of the price elasticity, reference effect factor and memory parameter. But they are decreasing with the decrease of the discount factor. We also make a comparison between optimal pricing strategy and myopic pricing strategy. The results show that long-term decision is superior to myopic strategy while customers' reference effect is taken into account during pricing-decision processes.