Supplier's pricing decision when facing irrational retailers

This paper studies the ordering behavior of retailers, who face a newsvendor problem, based on a laboratory experiment, and analyzes the supplier's optimal reaction to the irrational retailer. In our experiment, subjects face different cases where the wholesale price is randomly selected from a wholesale price set across rounds. According to the anchoring and insufficiently adjustment heuristic, we conduct an equation estimation to model the retailer's decision behavior using the data obtained from our experiment. Results show that the subjects' order quantities are averagely consistent with the mean anchor heuristic, which suggests the ordering decisions are made between the mean demand and the optimal order quantity. It is further found that, observing the retailer's degree of irrationality, a completely rational supplier should take advantage of it and establish a higher wholesale price. In this case, the supplier can obtain more profits than when facing a rational retailer due to the retailer's decision bias from his optimal strategy.