Impact of loss aversion on the newsvendor game with product substitution

Impact of loss aversion on the newsvendor game with product substitution

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Article ID: iaor20128003
Volume: 141
Issue: 1
Start Page Number: 352
End Page Number: 359
Publication Date: Jan 2013
Journal: International Journal of Production Economics
Authors: , ,
Keywords: demand, stochastic processes, inventory: order policies, game theory, supply & supply chains
Abstract:

This paper studies a newsvendor game in which two substitutable products are sold by two different retailers (newsvendors) with loss‐averse preferences. Each loss‐averse retailer facing stochastic customer demand and deterministic substitution rate will make an order quantity decision to maximize his expected utility. Since product substitution causes two retailers to make decisions in a competitive environment, game theory is used to find the retailers' optimal order quantities. It is shown that under certain conditions, there exists a unique Nash equilibrium in the newsvendor game. Under a symmetry assumption, each retailer's equilibrium order quantity is decreasing in the loss aversion coefficient and increasing in the substitution rate. Further, if the effect of loss aversion on the order quantity is strong enough to dominate the effect of competition, the total inventory level of a decentralized supply chain will be lower than that of a centralized supply chain. Numerical experiments are conducted to illustrate our results.

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