Modelling choice when price is a cue for quality a case study with Chinese wine consumers

Abstract

Experience products are those the quality of which cannot be ascertained until after consumption, forcing consumers to base their purchase decision on an expectation of the product’s quality. This expected quality is based on cues available before purchase, among which price is noteworthy, as consumers tend to believe that higher prices imply higher quality. But price also stresses the consumers’ budget restriction, inducing a double -and conflicting- global effect on purchase probability. Using the traditional formulation of Random Utility Models for experience goods (i.e. introducing all attributes directly in the utility function) can lead to an endogeneity problem due to the omission of expected quality, introducing bias on the results.
Using a stated wine choice experiment conducted in China as a case study, we correct for endogeneity by modelling each alternative’s expected quality as a latent variable, explained by all available quality cues, including price. Then we explain choice as a trade-off between price and expected quality. This allows us to separate both effects of price and correct for at least one source of endogeneity while being consistent with behavioural theory; this has either been ignored or not treated correctly in previous literature. Moreover, as the model requires only a single quality indicator for each alternative to achieve identification, the respondents’ burden increases marginally.
Our results show that the use of latent variables reduces endogeneity and effectively allows to measure both effects of price separately, obtaining higher significance and correct signs for its parameters.