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Predicting Buyer-Seller Pricing Disparities

Author

Listed:
  • Jeff T. Casey

    (W. Averell Harriman School for Management and Policy, State University of New York at Stony Brook, Stony Brook, New York 11794-3775)

Abstract
Numerous studies have shown that compensation demanded (CD) to give up a commodity often greatly exceeds willingness to pay (WTP) to obtain the same commodity, even in incentive compatible experiments that penalize strategic misrepresentation. Observed CD/WTP disparities are too large to be reconciled with traditional assumptions of economic rationality. A prospect theory-based behavioral framework for predicting CD and WTP is proposed which produces five distinct transaction encoding rules, any one of which can in principle apply to a buyer or a seller. According to this framework, CD/WTP gaps occur when buyers and sellers encode the prospective transaction differently, and gaps can occur in multiple ways, and vary in size, depending on encoding. The transaction encoding framework was tested in two experiments. In Experiment 1, model fits to subjects' CD and WTP for lottery tickets were consistent with the hypothesis that buyers and sellers encode transaction problems differently. Moreover, the quite large observed CD/WTP gaps were explained fully by encoding: When differences between buyers' and sellers' encoding processes were taken into account, their estimated utility (value) and probability weighting functions did not differ. The present framework and results show that the widely cited endowment effect is but one of several ways in which loss aversion can give rise to CD/WTP gaps. Consistent with this broadened perspective, Experiment 2 demonstrated CD/WTP gaps in the absence of an endowment effect (and in the absence of rational economic causes). The transaction encoding framework (1) provides a structured approach for predicting and testing the effects of a variety of task factors on pricing behavior and transaction outcomes, and (2) reveals the useful property that, in many cases, the ratio CD/WTP can be interpreted as a direct measure of the degree of loss aversion.

Suggested Citation

  • Jeff T. Casey, 1995. "Predicting Buyer-Seller Pricing Disparities," Management Science, INFORMS, vol. 41(6), pages 979-999, June.
    • Handle: RePEc:inm:ormnsc:v:41:y:1995:i:6:p:979-999
    DOI: 10.1287/mnsc.41.6.979
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    Citations

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    Cited by:

    1. Erica Mina Okada, 2010. "Uncertainty, Risk Aversion, and WTA vs. WTP," Marketing Science, INFORMS, vol. 29(1), pages 75-84, 01-02.
    2. Northcraft, Gregory B. & Preston, Jared N. & Neale, Margaret A. & Kim, Peter H. & Thomas-Hunt, Melissa C., 1998. "Non-linear Preference Functions and Negotiated Outcomes," Organizational Behavior and Human Decision Processes, Elsevier, vol. 73(1), pages 54-75, January.
    3. repec:cup:judgdm:v:3:y:2008:i:6:p:476-482 is not listed on IDEAS
    4. Daniel Villanova, 2019. "The extended self, product valuation, and the endowment effect," AMS Review, Springer;Academy of Marketing Science, vol. 9(3), pages 357-371, December.
    5. Florian Englmaier & Arno Schmöller, 2008. "Reserve Price Formation in Online Auctions," CESifo Working Paper Series 2374, CESifo.
    6. Haipeng (Allan) Chen & Akshay R. Rao, 2002. "Close Encounters of Two Kinds: False Alarms and Dashed Hopes," Marketing Science, INFORMS, vol. 21(2), pages 178-196, August.
    7. Gong, Cynthia M. & Lizieri, Colin & Bao, Helen X.H., 2019. "“Smarter information, smarter consumers”? Insights into the housing market," Journal of Business Research, Elsevier, vol. 97(C), pages 51-64.
    8. Stowasser, Till & Englmaier, Stowasser & Schmöller, Arno, 2016. "Determinants and Effects of Reserve Prices in Auctions," VfS Annual Conference 2016 (Augsburg): Demographic Change 145540, Verein für Socialpolitik / German Economic Association.
    9. Hochman, Guy & Ayal, Shahar & Ariely, Dan, 2014. "Keeping your gains close but your money closer: The prepayment effect in riskless choices," Journal of Economic Behavior & Organization, Elsevier, vol. 107(PB), pages 582-594.
    10. Paul Dolan & Martin Jones, 2002. "Explaining Attitudes towards Ambiguity: An Experimental Test of the Comparative Ignorance Hypothesis," Dundee Discussion Papers in Economics 131, Economic Studies, University of Dundee.
    11. Weber, Martin & Keppe, Hans-Jurgen & Meyer-Delius, Gabriela, 2000. "The impact of endowment framing on market prices -- an experimental analysis," Journal of Economic Behavior & Organization, Elsevier, vol. 41(2), pages 159-176, February.
    12. Englmaier, Florian & Schmöller, Arno, 2010. "Determinants and Effects of Reserve Prices in Hattrick Auctions," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 326, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    13. Janne Gustafsson, 2020. "Valuation of Research and Development Projects Using Buying and Selling Prices: Generalized Definitions," Decision Analysis, INFORMS, vol. 17(2), pages 154-168, June.
    14. Nash, Jane Gradwohl & Rosenthal, Robert A., 2014. "An investigation of the endowment effect in the context of a college housing lottery," Journal of Economic Psychology, Elsevier, vol. 42(C), pages 74-82.
    15. James R. Wolf & Hal R. Arkes & Waleed A. Muhanna, 2008. "The power of touch: An examination of the effect of duration of physical contact on the valuation of objects," Judgment and Decision Making, Society for Judgment and Decision Making, vol. 3(6), pages 476-482, August.
    16. Thomas Langer & Martin Weber, 2001. "Prospect Theory, Mental Accounting, and Differences in Aggregated and Segregated Evaluation of Lottery Portfolios," Management Science, INFORMS, vol. 47(5), pages 716-733, May.
    17. Schmöller, Arno, 2010. "Bidding Behavior, Seller Strategies, and the Utilization of Information in Auctions for Complex Goods," Munich Dissertations in Economics 11175, University of Munich, Department of Economics.

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