Modeling Reference Price Effect

Reference prices are latent internal norms
that consumers use as a basis against which to
compare current prices (Tellis, 1998; Winer,
1986). Reference prices are not observed and
cannot be ascertained by survey because of the
problem of demand bias. Even if they did not
exist, consumers would be tempted to answer in
the affirmative about them just to please the
researcher. The best way to test for reference
prices is by the prediction of behavior with
and without reference prices. For example, a
researcher can ascertain a model’s improvement
in fit with the data, if any, from the inclusion of
terms that capture reference price.
Current research suggests at least two components
of reference price (Rajendran & Tellis,
1994): first, a temporal or internal reference
price based on memory that probably develops
in response to past prices a consumer has paid
and, second, an external or contextual reference
price based on visible prices that probably
relates to the prices of other competing brands
available to the consumer at the time of purchase.
A complete model of response to pricing
should capture these effects of reference price.
Any of the models discussed above can account
for reference price effects by including independent
variables for these effects.