A Study On Dynamic Pricing Considering Consumers’ Bounded Rational Behavior

Recent years, more and more firms adopt dynamic pricing and revenue management strategy inmarketing and operations management. The key of implementing revenue management and dynamicpricing strategy lies in correctly understanding the consumer behavior. Nowadays, most of the scholarsin the field of revenue management and dynamic pricing assume that consumers are full rational, forexample, consumers have unlimited knowledge and computational abilities to make perfect purchasingdecisions. However, when faced with complicated market environment, and affected by incompleteinformation factors such as, psychological biases, cognitive biases as well as computational abilities,consumers cannot make rational decisions, and they rather make decisions in the framework ofbounded rationality.Decision bias is a classical bounded rational behavior, and it means the deviations from theoptimal decisions made by full rational behavior due to the factors such as, psychological biases,cognitive biases as well as affection influences. Although it is very important both academically andpractically to investigate the dynamic pricing strategies and its application under consumers’ boundedrational behavior in revenue management, the research on dynamic pricing considering consumerdecision bias bounded rational behavior, is still in its infancy. This dissertation proposes the dynamicpricing problem in the presence of consumers’ decision bias bounded rational behavior, and especiallyfocuses on the dynamic pricing strategies problem faced by firms who consider consumer inertia andconsumer two-stage choice behavior.This dissertation applies multiple theories such as operations management, economics, marketingscience, and adopts various research methods such as dynamic programming, modern heuristicalgorithms, numerical experiments and simulation to examine the dynamic pricing and assortmentoptimization strategies in the presence of decision biases of bounded rational consumers. The effects ofconsumers’ decision bias bounded rational behavior on firms’ dynamic pricing strategies are analyzed.Some practical marketing strategies are also discussed to mitegate the negative effects generated byconsumer inertia and two-stage choice behavior. The main literatures on consumer behavior theory anddynamic pricing models are reviewed. The literature review covers the following topics, including theconcept and research areas of revenue management, the theory and research method of dynamic pricing,consumers’ behavior theory, consumers’ full rational behavior theory, consumers’ bounded rational behavior theory, the theory and application of consumer inertia and two-stage choice behavior, dynamicpricing of full rational consumers, and dynamic pricing and assortment optimization under consumer’sbounded rational behavior. Future research areas are also proposed regarding the aspects on dynamicpricing and revenue management of bounded rational consumer behavior.The main research work andresults are summarized as below:（1）A dynamic pricing problem for a monopolist selling single perishable good to consumerswho may be influenced by inertia is studied. Consumer inertia refers to consumers’ inherent tendencyof purchase procrastination and may induce consumers to wait even when immediate purchase isoptimal from an objective perspective. A multiperiod dynamic programming model of a monopolistwho dynamically pricing its products in the presence of consumer inertia is developed and the optimaldynamic pricing policy is also derived. The results show that1）consumer inertia hurts firm’s expectedrevenues;2）the optimal prices are monotonically decreasing in both inertia depth（the extent of inertia）and inertia breadth（the probability with which a consumer exhibits inertial bias）;3）through numericalillustrations, it shows that the marginal effects of inertia depth on optimal prices and expected revenuesare decreasing, whereas the marginal effects of inertia breadth are increasing. Some marketingstrategies are provided to mitigate the negative effects of consumer inertia. This research provides thetheoretical foundation for firms to understand consumers’ inertia behavior, and the effects of consumerinertia depth as well as inertia breadth on its expected revenues and optimal prices. The research alsoprovides decision supports to develop and improve firms’ operational management.（2）A dynamic pricing problem for substitutable products in the presence of inertial consumers isstudied. Consumers typically choose among a variety of competing substitutes. First, a dynamic pricingdecision model of substitutable products considerting consumer inertia is developed. Then the firm’soptimal prices given initial inventory of substitutable products and consumer inertia are presented.Through numerical illustrations, it is demonstrated that1）under substitutable products’ situation,consumer inertia significantly produce negative effects on firm’s expected revenues;2）the negativeeffect is decreasing as inertia depth increases, and increasing as inertia breadth increases;3）the optimalprices’ evolvement patterns of substitutable products under different inventory levels are also examined，that is，the optimal price of each product variate does not necessarily decreases in time or inventorylevel.This research provides theoretical basis for firms to understand the effects of consumer inertia onthe dynamic pricing strategies of substitutable products.（3）A multiperiod dynamic pricing problem of a monopolist selling substitutable perishable products to consumers who have two-stage choice behavior is studied. Consumer’s two-stage choicebehavior refers to the phenomenon that due to decision bias and ability limitation, consumers usuallyform a choice set first during the products viewing stage, and then select a product from this simplifiedchoice set. In the framework of network revenue management, a decision model of substitutableproducts considering the two-stage choice behavior is formulated using the finite-horizon dynamicprogramming. It is then approximated as a constrained nonlinear programming problem, and the staticoptimal pricing policy is derived using augmented Lagrange method. Finally, through numericalexperiments, it finds that1）consumers’ two-stage choice behavior hurt retailers’ expected revenues;2）the expected revenues stay stable and then drop significantly as the intial resource capacity scarcitylevel increases;3）the static optimal prices increase gradually first and then pick up quickly as the intialresource capacity scarcity level increases.4）the average expected revenues increase as the size ofchoice set increases, and the increase rates of the average expected revenues are monotically decreasing.This research provides theoretical basis for firms to understand the effects of two-stage choice behavioron retailers’ expected revenues as well as static optimal prices. Furthermore, it provides decisionsupports for firms to cope with the negative effects generated by consumers’ two-stage choice behavior,and it helps firms to optimize as well as improve its’ dynamic pricing policies.（4）A multiple stage assortment optimization problem faced by a monopoly firm in the presenceof consumers’ two-stage choice behavior is studied. In the framework of revenue management, anassortment optimization model with fixed prices considering consumer’s two-stage choice behavior isfirst proposed, and the choice deterministic linear programming method（CDLP）is designed toapproximate the solution. Furthermore, the maximum expected revenues and the static optimal pricesare derived. Moreover, the above model is expanded to jointly optimize pricing structure andassortment optimization, and its solution is also derived. Through numerical examples, it shows that1）consumers’ two-stage choice behavior hurt firms’ average expected revenues;2）firms’ averageexpected revenues increase as the size of choice set increases;3）the average types of products offerand the average time of products offer first increase and then decrease as the size of choice setincreases. This research provides theoretical foundation for retailers to thoroughly understand theeffects of consumers’ two-stage choice behavior on its expected revenues and optimal productassortments. Also, the research provides directions for making corresponding marketing strategieswhen facing two-stage choice behavior. Based on the above analysis and discussion, the main innovations and contributions of thisdissertation are summarized as below:（1）Relax the assumptions of two stage consumer inertia dynamic pricing. Both situations wherea monopolist sells single product and substitutable products are considered, and consumer inertia isincorporated in the mutiperiod dynamic pricing programming models for the first time. Moreover, thestructure properties are analyzed and the optimal dynamic pricing strategies are derived. A series ofnew results are developed. For example, the negative effects of consumer inertia depth and inertiabreadth on firms’ expected profits are verified, as well as the relationship between optimal pricingpolicies under different inventoy levels, the price evolvement patterns of substitutable products and theoptimal prices of different products is systematically analyzed.（2）By incorporating consumers’ two-stage choice behavior in the context of dynamic pricing forthe first time, a new dynamic pricing model based on two-stage choice demand is constructed. Acompensate linear decision heuristics are incorporated in the model, and the relationship betweenproducts attributes, consumer preferences and marketing strategies are considered. The effects oftwo-stage choice behavior on firms’ expected revenues and static optimal prices are systematicallyinvestigated for the first time.（3）By incorporating consumers’ two-stage choice behavior in the context of dynamic pricingstructure and assortment optimization for the first time, a dynamic pricing structure and assortmentoptimization model considering two-stage choice behavior is constructed. The effects of two-stagechoice behavior on firms’ expected revenues and optimal assortment selections are systematicallyinvestigated for the first time.（4）Based on the above theoretical analysis and the causes of consumers’ inertia and two-stagechoice behavior, some new practical marketing strategies to eliminate or mitigate the negative effectsgenerated by these two behaviors are provided.