“A Reference-Dependent Utility Model of Attraction and Compromise Effects”
by Serdar Sayman
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Attraction effect refers to increased preference for a target option relative to its competitor when a third option (decoy) dominated by the target is present. Compromise effect is for the case where the decoy makes the target the intermediate option. We submit that a reference-dependent utility model can accommodate both effects. More specifically, utility includes both regular (consumption) and reference-dependent (gain-loss) terms; and any option in the choice set can serve as reference with a respective probability. We examine how the incumbents’ utilities change with the position of the decoy in the attribute space and show that decoy benefits the target (i.e., the closer incumbent), in accord with the conceptualization of attraction and compromise effects. We identify that for both context effects, the target gains advantage due to buyers who treat the decoy as the reference in the extended set but would have treated the competitor (i.e., further incumbent) as the reference in the core set. A novel implication of our model is empirically tested and supported.