Consumer Learning and Brand Loyalty When Product Quality Is Unknown
Goering, Patricia Ann
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https://hdl.handle.net/2142/70738
Description
Title
Consumer Learning and Brand Loyalty When Product Quality Is Unknown
Author(s)
Goering, Patricia Ann
Issue Date
1983
Department of Study
Economics
Discipline
Economics
Degree Granting Institution
University of Illinois at Urbana-Champaign
Degree Name
Ph.D.
Degree Level
Dissertation
Keyword(s)
Economics, Theory
Abstract
Some recent research has focused on the behavior of agents under incomplete information, one aspect of which is the effect of learning on optimal decision making. This thesis explores the effects of consumer learning about product quality on a firm's optimal pricing strategies under different market structures.
A two period model is presented in which the average quality of the product is exogenously determined and is unknown to consumers. Consumers' purchasing decisions are based on their expectations about average quality. Consumers use information about average quality acquired by observing a sample to revise their expectations. Because consumers receive different samples, their expectations vary. As learning occurs, the demand curve shifts. Current prices which determine the number of purchasers affect future demand. The "manipulating" firm increases profits by taking this effect into account when setting current prices.
The main results of the model under different market situations are, first, when no entry occurs or when several competitive firms enter, a sufficient condition is specified under which there exists a unique level of average quality such that if the product's average quality is high, the manipulating firm's optimal first period price is lower than the "non-manipulating" firm who chooses current prices to maximize current profits. A low initial price increases the number of consumers who, on average, raise their expectations and are willing to make future purchases at higher prices. If the product's average quality is low, however, the optimal "manipulating" first period price is higher than the non-manipulating price, decreasing the rate of consumer learning.
Second, when a single firm enters, a Stackelberg equilibrium is established. The incumbent must then consider not only the direct effect of its first period price on its future demand, but also the indirect effect on the entrant's demand and price which, in turn, affects the incumbent's demand. It is shown that these two forces may pull in different directions, limiting the incumbent's ability to manipulate future demand.
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