Internal and External Reference Effects in a Two-Tier Supply Chain

Abstract

We study a two-tier supply chain with a newsvendor retailer that has an internal reference effect related to its own profit as well as an external reference effect centered on the profit of the supplier. We show that the internal and external reference effects in isolation can have opposite effects on the wholesale price set by a supplier who has full knowledge on the retailer's ordering bias. The internal reference effect, which is driven by the relative disutility from ex-post inventory error, causes the supplier to increase the wholesale price, whereas the external effect, which results from disadvantageous profit inequity, causes the supplier to decrease the wholesale price. While the in..