An Economic Choice Model for Lexicographic Preferences

Abstract

Consumer's preference structure varies across product categories. For some durable goods, such as laptops and smartphones, consumers tend to distinguish a product from its competing ones by differences in several features ordered in their importance. Under this preference tructure, so called lexicographic preference, it is not easy to find the optimal marketing mix strategy because of two reasons: First, there is no simple functional form to link the ordinal preferences revealed in choice observations to measurable utility that allows us to conduct policy experiments for marketing mix variables. Second, the latent process of ordering attributes according to their importance cannot be easily calibrated in the conventional manners such as MLE, GMM, and Bayesian methods. In this paper, we propose an economic choice model with a recursive utility specification to measure lexicographic preferences, and introduce a data augmentation technique to estimate the latent ordering process. The proposed model is applied into a conjoint analysis for laptop choice, where we find that the recursive utility specification leads to a better model fit and a different pricing strategy compared to the conventional linear utility specification.

Keywords: Conjoint analysis, Optimal pricing, Bayesian estimation