Imperfectly-Rational Agents, Volatility of Reserves and Customer Markets

Abstract

Potential customers in customer markets are typically dichotomised into actual and prospective customers. If the firm holds its price firm, the actual customers hold their reserves/reservation price firm and repeat their purchases. On the other hand, prospective customers’ reserves may be volatile due to their non-equilibrium market experience. One may regard a prospective buyer with a volatile reserve as imperfectly rational. On the other hand, one may suppose that an actual customer with a firm reserve is fully rational. We examine this hitherto-neglected asymmetry in customer markets to highlight that a firm can use imperfectly rational and prospective customers-characterised by their volatile reserves-as a European option. As the volatility increases, so does the value of the option of selling the products to the prospective customers. We also establish that volatility of reserves and hence imperfection in rationality of buyers, can have positive impact on output and employment in customer markets.