Based On Prospect Theory Of The Third Generation Of The Newsboy Problem Study Of Reference Point

Empirical study on decision-making bias and its correction in Newsvendor Problem is result from Schweitzer and Cachon(2000). The authors observed in experiment that subjects’decisions often deviate from optimal order quantity, ordering too few of high profit products and too many of low profits products. They thought this too low/too high pattern could be interpreted by ex-post minimizing inventory error preference as well as anchoring and insufficient adjusting. Besides, they refused the explanation of prospect theory with a experiment. Since then, more and more researches are try to explain this bias, and the most popular behavioral factors are:anchoring and incomplete adjustment, demand chasing, regret aversion, minimize ex-post inventory error and loss aversion. However, from the view of utility and weight function of prospect theory, prospect theory can be taken as a extention of anchoring and insufficient adjustment based on a reference point, demand chasing and loss aversion. It means the theory can explain more newsvendor decison bias and the key is the reference point. It should be another reference point for subject to make decision instead of zero profit in Schweitzer and Cachon(2000)’s experiment, so subjects are risk seeking and order too high pattern in low pure profit level.So based on the third generation prospect theory we built ordering models take reference points as follows; zero profit, average income, profit in each term when its order quantity is mean demand, prior profit and the maximum expected profit, which are belong to three kinds as survival, status and goal motivations. Firstly we gain the value of risk aversion parameter in gain, risk seeking parameter in loss and loss aversion parameter through experiment and use them in the model. Then we stimulate inventory ordering experiment whose design includes: mixed high/low profit products or pure low profit level and intensive or general reference point emphasis to study what are the key for subjects to make decision and whether it is right to the predict of peospect theory.The results indicate the third generation prospect theory can explain most of the newsvendor bias. To all products, the most important reference points that affect subjects decsion are mean profit and maximum expected profit, and other reference points’ effect were quite low. The maximum expected profit reversely adjust subjects’ order quantity, while the average profit direct regulate it. For the low-profit products the two reference points’ affect with intensive reference points treatment are higher than the counterpart with general treatment, which is conversely for high profit products.