63

chaptEr 3
LEARNING MODELS
s. sriraM aNd pradEEp K. chiNtaGuNta
Abstract
Choice models typically assume that agents know with certainty the utility they would derive from
various alternatives. Such an assumption is likely to be violated in instances where (a) the agent
is new to the context or (b) the choice set has new alternatives. Learning models specify a mecha-
nism by which consumers resolve uncertainty regarding products or their characteristics in such
turbulent contexts. In this chapter, we provide a critical review of the extant learning literature
in marketing and economics. We also discuss some avenues for future research in this area.
Introduction
The extensive literature on choice models has been built on the premise that consumers derive
utility from the various alternatives in their choice set and choose the alternative that gives them
the greatest utility. Typically, these models assume that consumers know the various components
of this utility with certainty. This would be the case for categories in which (a) consumers make
purchases regularly and (b) there are no new product introductions and consumers have been
participating in the category over an extended period of time. However, if consumers are either
new to the category or if the category experiences several new product introductions, this as-
sumption is likely to be violated. In such instances, consumers would perceive some uncertainty
in the utility they would derive from the various alternatives. Consequently, this would play a
role in their choice decision. Moreover, consumers may try to resolve this uncertainty by learning
about the utility they would derive from the products through various information sources such
as actual purchase and consumption of the product, advertising messages, and word-of-mouth
interactions with other consumers. Learning models specify the mechanism by which consumers
use these various sources of information to resolve their uncertainty. A choice model that formally
incorporates learning behavior would then be able to assess the relative effcacy of the different
information sources in aiding consumer learning.
The literature that considers consumer learning can be broadly classifed into two streams. The
frst consists of reduced-form models that allow for the evolution of a consumers brand preferences
and price sensitivity parameter to be a function of her past experience in the category (Heilman,
Bowman, and Wright 2000) or due to her exposure to advertising by these brands (see, for example,
Jedidi, Mela, and Gupta 1999; Sriram, Chintagunta, and Neelamegham 2006; Sriram and Kalwani
2007). Therefore, these models do not provide a structural representation of the learning mechanism.
One criticism of such reduced form models is that they may not be invariant to policy changes (also
known as Lucas Critique). Therefore, they may not be useful if the focus of the researcher is to
64 S. SRIRAM AND PRADEEP K. CHINTAGUNTA
understand the implications of signifcant policy changes. The second stream of literature explicitly
accounts for how consumers update their beliefs regarding components of their utility about which
they are uncertain. The structural nature of such models provides some defense against the Lucas
Critique. Most of these studies assume that consumers update their beliefs in a Bayesian fashion
with the extent of updating being related to their perceived precision of the signals that aid in such
learning. In this chapter, we present a review of this latter stream of the learning literature. While
the above discussion was based on consumers learning about the utility they would derive from the
various alternatives, the literature encompasses various other contexts, such as physicians learning
about a drug and managers learning about the attractiveness of a market.
The rest of the chapter is organized as follows. First, we begin by discussing the basic structure
of learning models. We then discuss the differences between the various learning models in the
marketing and economics literatures in terms of the agent who is learning, the entity that the agent
is uncertain about, and the signals that help in learning. Subsequently, we talk about how the basic
learning model has been extended in the literature. The following section sheds some light on po-
tential avenues for future research, and the fnal section provides some concluding comments.
The Basic Structure of Learning Models
Learning models are typically characterized by the following four aspects: (a) an agent, (b) a
component of the agents utility function that she is uncertain about (an unknown entity), (c) sig-
nals that the agent receives about the unknown entity, and (d) a mechanism by which information
in the signal is used to resolve the uncertainty in (b). A common example in marketing involves
consumers (the agents) who are uncertain about the quality of the product they are deciding to
purchase (the unknown entity). Upon purchase and experience of the product, they receive some
information regarding its true quality (the signal). The signal is usually assumed to be noisy,
that is, a single purchase or experience usually does not resolve all the uncertainty regarding the
product. In a standard Bayesian learning model (the mechanism), the agent has some prior belief
about the quality of the product. The (noisy) signal the consumer receives from the purchase
and use of the product allows the agent to combine the prior belief with the signal in a Bayesian
fashion to update beliefs about the products quality. Usually, researchers assume that the noisy
information that agents receive each period comes from a distribution whose mean equals the true
value of the unknown entity, that is, that the signals are unbiased. Hence, if the agent receives
signals over an extended period of time by making repeated purchases, the updated belief about
product quality will converge to its true value. Below, we present a formal discussion of the
model structure in the context of this example.
Consider a market with only one new nondurable product that can be purchased every period.
Consumers in such a market decide on whether to purchase the product or not during each period
t, t = 1, 2, . . . , T. Further, we assume that consumers can make only one purchase during each
period. Let Q be the true quality of the product. In our illustrative learning model, consumers do
not know this true quality. At period 0, all consumers start with a prior belief that the quality of
this product is normally distributed with mean Q
0
and variance s
2
0
, that is,
Prior ~


4 1 . (1)
In period 1, consumers would make their purchase decisions based on this prior belief. If
consumer i, i = 1, 2, . . . I, purchases the product, she can assess the quality of the product from
her consumption experience, Q
Ei1
. If we assume that the consumer always derives the experience
LEARNING MODELS 65
of quality that is equal to the true quality Q
Ei1
Q, i, t, then this one consumption experience
is suffcient to assess the true quality of the product. However, in reality, this experienced quality
might differ from the true quality, Q, because of (a) intrinsic product variability (Roberts and Urban
1988) and/or (b) idiosyncratic consumer perceptions (Erdem and Keane 1996). Hence, researchers
typically assume that these experienced quality signals are draws from a normal distribution whose
mean equals the true quality, that is, that these are unbiased signals. Thus, we have
a

4 (LW
4 1 4 , , L 7 W = = , (2)
where

4
captures the extent to which the signals are noisy. Thus, for learning to extend beyond
the initial purchase, we need

>
4
.
Subsequent to the frst purchase (and consumption experience) the consumer has some more
information than the prior she started with. Consumers use this new information along with the
prior to update their beliefs about the true quality of the product in a Bayesian fashion. Specifcally,
since both the prior and the signal are normally distributed, conjugacy implies that the posterior
belief at the end of period 1 would also follow a normal distribution (DeGroot 1970) with mean
L
4 and variance

L
such that

(L L L L
4 4 4 + = and (3a)

4
L

+
=
, (3b)
where

4
4
4
L

+
=
+
=
and (3c)

4
4
4
L

+
=
+
=
. (3d)
This posterior belief at the end of period 1 acts as the prior belief at the beginning of period 2. Thus,
when the consumer makes a purchase decision in period 2, she would expect her quality experience
to come from this distribution, that is, a
a

L L L
4 1 4 . On the other hand, a consumer who does
not make a purchase in period 1 will use the same prior in period 2 as she did in period 1. Hence, we
can generalize equations 3a, 3b, 3c, and 3d for any time period t, t = 1, 2, . . . , T, as follows:

(LW W L LW
4 4 4 + =

, (3a)

=
+
=
+
=
W
4
L
4
LW
LW
LW
,
,

(3b)
66 S. SRIRAM AND PRADEEP K. CHINTAGUNTA

4 W L LW
4
4
LW
W L
W L
LW
,
,

+
=
+
=

(3c)

4 W L LW
W L LW
4
LW
W L
4
LW
LW
,
,
,
,

+
=
+
=

, (3d)
where I
it
is an indicator variable that takes on the value 1 if consumer i makes a purchase in pe-
riod t and 0 otherwise. Similarly, when the consumer makes a purchase in period t+1, she would
assume that the quality of the product,

a
+ LW
4 , comes from this posterior distribution at the end of
period t, that is, a
a

LW LW LW
4 1 4
+
. Equations 3a, 3b, 3c, and 3d imply that as the number of
consumption experiences increases, the consumer learns more and more about the true quality
of the product. As a result, her posterior mean would shift away from her initial prior and move
closer to the true mean quality. Similarly, as she receives more information, her posterior variance
would decrease.
In order to demonstrate how a consumers posterior belief would evolve as she receives
these signals, we performed a simulation wherein the true quality of the product, Q, is set at
5. The consumer has a prior belief that the true quality of the product, Q
0
, is 0 with a variance of
5 (

= ). The consumer receives unbiased signals around this true quality with a signal vari-
ance of 2 (

=
4

). In Figure 3.1, we plot the evolution of the posterior mean and variance as the
number of purchase occasions increase. As discussed above, the fgure reveals that the consumers
posterior belief about the true quality of the product converges to its true value as she receives
more signals. Furthermore, her uncertainty about this belief (posterior variance) falls with each
additional signal and tends to zero asymptotically.
This concludes our discussion of a basic mechanism by which consumers learn about the quality
of a new (to them) product. Later we will discuss other learning mechanisms. Now we turn to a
discussion of the utility function that drives purchases.
Specifcation of the Utility Function
For the sake of simplicity, we defne the utility that the consumer derives from the product at time
t as a function of her quality perception and the price of the product at that time. As discussed
above, when a consumer makes a purchase decision at period t, she still perceives some uncer-
tainty about the quality of the product she would receive. Hence, her utility will also be a random
variable. Specifcally,

LW W LW LW
S 4 I X + =
a

a
, (4)
where
LW
X
a
is the utility that consumer i derives from purchasing the product at time t, p
t
is the
price of the product at time t, is the price sensitivity parameter, and
it
is a consumer and time-
LEARNING MODELS 67
varying idiosyncratic term that is not observed by the researcher.
1
Since the consumer does not
know the true quality and, hence, the true utility, she makes her purchase decision based on the
expected utility,

LW W LW LW W LW LW
S 4 I ( S 4 I ( X ( + = + = @
a
> @
a
> @
a
> , (5)
where E[.] is the expectation operator. The expectation is taken over the prior distribution at the
beginning of that period (or the posterior distribution at the end of the previous period). Since
the error term is perfectly known to the consumer and unknown only to the researcher, it can be
taken out of the expectation operator as in equation 5. Further, if we assume that the deterministic
component of the utility from not purchasing is 0 and the error term
it
follows a type I extreme
value distribution, we can write out the probability that consumer i would make a purchase at
time t, Pr
it
as

)|) ; ,
~
( | exp( 1
)|) ; ,
~
( | exp(
Pr

W LW
W LW
LW
S 4 I (
S 4 I (
+
=
. (6)
The specifcation of the utility function in equation 4 will have implications for how the posterior
mean and variance enter the expected utility in equation 5 and hence the probability of purchase
in equation 6. For example, if f(.) is a linear function of
LW
4
a
such that

LW W LW LW
S 4 X + + =
a
a
, (7a)

LW W W L
LW W LW LW
S 4
S 4 ( X (


+ + =
+ + =

@
a
> @
a
>
. (7b)
Figure 3.1 Change in Posterior Mean and Variance with Number of Purchases
0
1
2
3
4
5
6
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
No. Purchases (Signals)
True Quality Posterior Mean Posterior Variance
68 S. SRIRAM AND PRADEEP K. CHINTAGUNTA
The expression for the expected utility in equation 7b implies that it depends solely on the
posterior mean from the previous period and is independent of the posterior variance. On the
other hand, concave or convex specifcations of f(.) would lead to expected utilities that depend
on both the posterior mean and variance. More specifcally, a concave utility function would
imply that the consumers are risk averse. Consequently, the expected utility would be nega-
tively infuenced by the posterior variance. Likewise, a convex utility function would have the
posterior variance affecting the expected utility positively. In Table 3.1, we present the utility
functionandtheexpectedutilityforthreecommonlyusedfunctionalformsintheliterature
linear, quadratic, and constant absolute risk aversion (CARA). Note that the term in the qua-
dratic and CARA specifcations corresponds to the level of risk aversion, with positive values
corresponding to risk-averse consumers (concave utility) and negative values corresponding to
risk-seeking consumers (convex utility).
Learning Models in Marketing and Economics
We now turn our attention to a discussion of the different applications of learning models in the
marketing and economics literature. Specifcally, we break down the discussion into how these
studies differ in terms of the following three questions: (a) who is learning? (the agent), (b) what
are they learning about? (the uncertain entity), and (c) how do they learn? (the signal). In Appendix
3.1, on pages 8283, we provide a summary of selected studies on learning. The appendix also
provides details on how these studies differ on these three dimensions.
Who Is Learning? (The Agent)
Broadly, there are three types of agents in the literature: (a) consumers who are making decisions
regarding their own consumption or purchases, (b) physicians making decisions on behalf of their
patients, and (c) managers making decisions on behalf of their frms. As regards the frst group,
consumers, the literature on learning models spans several industries including consumer packaged
goods (see, for example, Ackerberg 2003; Erdem and Keane 1996; Mehta, Rajiv, and Srinivasan
2003, 2004), consumer durables such as automobiles (Roberts and Urban 1988) and computers
(Erdem, Keane, Oncu, and Strebel 2005), and services such as local telephone (Narayanan, Chin-
tagunta, and Miravete 2007) and wireless (Xiao, Chan, and Narasimhan 2007). The choice of the
category has typically been dictated by the nature of data required to infer consumer learning. Since
inference of learning requires us to observe consumer decisions over several time periods, most
of the work has been in the context of frequently purchased consumer packaged goods or services
such as telephone and wireless where consumers are not bound by a contract and therefore have
the option of switching between services during each period. A casual perusal of the appendix
would confrm this. The only exceptions are the studies by Roberts and Urban (1988) and Erdem
and colleagues (2005), set in the context of consumer purchases of automobiles and computers,
respectively. Clearly, if one needs to infer learning in these contexts based on how consumers
modify their purchases over time, it would require data that track the purchases of these consumers
over several purchase occasions. Given the lifetime of these categories (especially automobiles),
we may have to track purchases over several decades to arrive at a reasonably large purchase his-
tory to infer learning. Therefore, in both cases, inference regarding learning is not based on repeat
purchases by consumers. Rather, they use data from consumer surveys to infer how consumers
learn over time. For example, Roberts and Urban investigate how car buyers would learn about a
new car model through word of mouth from current customers. In order to infer this, they collect
69
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70 S. SRIRAM AND PRADEEP K. CHINTAGUNTA

information from potential buyers of the model regarding their willingness to recommend the
model to other potential buyers.
The second class of agents includes physicians who make decisions regarding the drugs to
prescribe to their patients. Past studies have investigated decisions by these agents in a broad class
of prescription drugs, including those for allergies (Narayanan, Manchanda, and Chintagunta
2005), anti-ulcer medication (see, for example, Coscelli and Shum 2004; Crawford and Shum
2005; Chintagunta, Jiang, and Jin 2008), erectile dysfunction (Narayanan and Manchanda 2009),
and heart disease (Ching 2008). Since the agent (physician) and the end consumer (the patient)
are not the same, this context is vulnerable to the critique that the two players may have different
objectives. However, past research has argued that the fear of malpractice lawsuits would ensure
that the physicians have the same objectives as their patients.
The third category of agents comprises managers making decisions on behalf of their frms.
Typically, the decision revolves around whether they should continue with a product or a service
in a given market. For example, Hitsch (2006) investigates the decision of a manager of a brand
of cereals on whether to continue with a new product or discontinue it. Similarly, Dixit and Chin-
tagunta (2007) consider the decision of discount airlines on whether to exit a city-pair market.
Other researchers such as Balvers and Cosimano (1990) deal with the situation in which rational,
forward-looking frms are uncertain about their true demand and use pricing strategically to gener-
ate more informative quantity observations. Yet another category of research along these lines is
the adoption of an innovation of uncertain proftability by a frm. Here the frm receives signals
on the proftability of the innovation, thereby learning about proftability from them; its decision
problem is in the form of an optimal stopping problem in which the stopping value is the expected
return from adoption, and the value from optimal continuation is the discounted expected value
of the next piece of information (see Jensen 1982). Of the three categories of agents, strategic
decision-making by managers appears to be the least studied in the literature.
What Are They Learning About? (The Uncertain Entity)
The most common entity in the literature that agents learn about is the overall quality of a product.
These studies typically start with the assumption that, at the beginning of the data, the agent is
uncertain about the products true quality. As the agent makes a series of decisions (such as pur-
chase and subsequent consumption of the product), she obtains unbiased information regarding
the true value of the unknown entity, which helps in updating her beliefs regarding that value, as
discussed above in the section on the basic structure of learning models. In the basic structure, the
true quality does not vary across agents (see, for example, Erdem and Keane 1996). This basic
structure has been extended along two dimensions. First, researchers have extended the notion of
an overall true quality to accommodate the fact that the product match might vary across agents
(Crawford and Shum 2005). For example, when physicians prescribe drugs to patients, they are
likely to consider the fact that the effcacy of a drug would vary across patients. Therefore, apart
from drawing inferences about the overall quality of a drug, they would also learn about how a
drug matches a particular patient (see, for example, Chintagunta, Jiang, and Jin 2008). Similarly,
agents can have different preferences for consumption that could make some options more attrac-
tive than others. For example, Narayanan, Chintagunta, and Miravete (2007) consider the choice
of fxed-rate or metered calling plans for local telephone service. Given uncertainty about their
true consumption rate or type (due to being only on the fxed-rate plan till the introduction of the
metered plan), the agents (consumers) have to choose a calling plan that would suit their needs best.
As consumers learn about their true types, they would converge on a plan that is the best match
LEARNING MODELS 71
for them. Hence, this bears similarity to the case where physicians infer the patient-drug match
based on patient feedback. In a variant of this extension, Coscelli and Shum (2004) investigate
how physicians learn about the effcacy of a drug in treating different diagnoses.
In addition to extending the basic structure to accommodate differences in match across agents,
researchers have added more dimensions of learning. For example, Mehta, Rajiv, and Srinivasan
(2003) extend the basic learning model of consumers learning about quality to also accommodate
consumer price search behavior. Consumers are not fully informed about the price levels of the
products in the category and need to undertake a costly search to uncover these prices. Since they
are assumed to know the distribution of prices for each of the brands, their choice of the size of the
consideration set represents a trade-off between the cost of searching for as many prices as there
are brands in the set with the expected benefts from those products. Thus authors assume that
the consumers follow a fxed sample size search strategy. At the same time, they also assume that
learningaboutthetwoentitiesqualityandpriceareunrelated.Therefore,informationregard-
ing the price of a product does not help in updating beliefs about the products quality. Recently,
Erdem, Keane, and Sun (2008) have allowed for both price and advertising to infuence consumers
learning of quality. Similarly, Crawford and Shum (2005) consider two unknown entities in the
context of prescription drugs: symptomatic and curative effects. While the symptomatic effect
corresponds to the effcacy of the drug in relieving symptoms, curative effects relate to the abil-
ity of the drug to cure the patient. As in Mehta, Rajiv, and Srinivasan (2003), they assume that
learning about the effcacy of the drug on one effect does not inform the patient or the physician
about its effcacy on the other effect.
Ackerberg (2003) extends the notion of learning about multiple entities by allowing their sig-
nals to be correlated. In his model set in the context of packaged goods, consumers are uncertain
about (a) the quality and (b) advertising expenditures of different brands in the yogurt category.
The uncertainty about advertising expenditures arises because consumers may not watch all the
advertisements of the different brands. Therefore, based on their viewing patterns, consumers
update their beliefs about the extent to which different brands spend on advertising. Ackerberg
further argues that consumers might view advertising expenditure by a brand as a signal of its true
quality. For example, only brands that have a high enough quality can afford to invest heavily in
advertising. He achieves this by allowing the prior beliefs of the consumers regarding quality and
advertising levels to be correlated. Therefore, unlike in Mehta, Rajiv, and Srinivasan (2003) and
Crawford and Shum (2005), learning about one unknown entity (advertising expenditure) also
helps in learning about another unknown entity (quality).
How Are They Learning? (Signals)
Researchers have considered how agents learn from a variety of signals such as consumption, us-
age, advertising, detailing (in case of physicians), and market demand (in case of managers). As
discussed above in the section on the structure of learning models, the standard assumption in the
literature is that these signals are unbiased (that is, mean = true value of the unknown entity) but
noisy indicators of the true value of the unknown entity. What is the source of the signal noise? In
instances where the signal is in the form of consumption, the noise could be because of the inher-
ent variability in the product (Roberts and Urban 1988). It could also be due to market conditions
(Hitsch 2006; Dixit and Chintagunta 2007) as well as due to the inability of the agents to perfectly
evaluate the true value of the signal. For example, it might take consumers several usage occa-
sions to evaluate the stain-removal property of detergents (Erdem and Keane 1996). In the case
of signals such as advertising and detailing, the noise might refect the level of precision in the
72 S. SRIRAM AND PRADEEP K. CHINTAGUNTA
signal. If the agents view the signal as being less precise, it would take several signals to change
their beliefs about the true value of the unknown entity. Such low-precision signals would have
a relatively high variance. At the other end of the spectrum, one can envision scenarios wherein
the agent realizes the true value of the unknown entity after receiving one signal. For example, it
would typically take only one viewing of a movie to evaluate its true quality. In such instances,
the signal would have no variability. Nevertheless, most applications in marketing and economics
have considered only noisy signals. However, the case of one-shot learning is an outcome that is
nested in such models (that is, precision approaches asymptotically).
We can classify the signals into two broad groups based on whether or not they are an outcome
of the agents decision. We call these intrinsic and extrinsic signals respectively. For example, con-
sumption experience is an outcome of the consumers decision to purchase the product. Therefore,
it can be classifed as an intrinsic signal. Similarly, the realization of demand for a new product
is a result of a managers decision to keep the product in the market. In the case of a physician,
the feedback signals received from patients regarding the effcacy of a prescription drug are real-
ized as a consequence of his decision to prescribe the drug. On the other hand, when a consumer
receives advertising signals regarding a product, it is not a result of her actively seeking the in-
formation. Therefore, we can classify it as an extrinsic signal. Detailing efforts by pharmaceutical
companies directed at physicians fall in the category of signals that are generated by frms and
not by the direct actions of the physicians (although presumably a physician is detailed based on
his prescription activity).
Extensions of the Basic Learning Model
In this section, we discuss some ways in which the basic learning model discussed in the previ-
ous sections has been extended in the literature to accommodate more realistic decision making
by agents. First, we discuss the extension of the decision horizon for the agent from myopic to
forward-looking wherein they consider the effect of learning in being able to make more informed
decisions in the future. Next, we discuss an extension that accommodates instances where the
agents might not fully retain the information they get from the signals. We conclude the section
with a discussion of a learning model in which the agents learn from the action of other agents
even when these agents do not directly communicate with each other. We discuss this under the
subsection entitled Silent Word of Mouth.
Decision Horizon
The basic structure of learning models discussed earlier assumes that the agents maximize only
the current utility, that is, they are myopic. The appendix suggests that most of the work in the
literature of learning models falls in this category. However, one can envision scenarios when the
agents would consider payoffs beyond the current period while making their decisions. To illustrate
this point, consider equations 3a and 3b, which provide the expressions for the posterior mean
and variance. These equations imply the following. First, from equation 3a it is clear that the
prior mean belief that an agent has about the uncertain entity for the next period is a function of
the current mean and the information that the agent receives during this period. Furthermore, as
shown in Figure 3.1, when the signals are unbiased, the prior mean of the unknown entity would
asymptotically converge to its true value. Therefore, the agent realizes that as she gathers more
information regarding the unknown entity, her beliefs regarding its mean are likely to be closer to
the true value. Second, from equation 3b it is clear that the prior variance is strictly decreasing in
LEARNING MODELS 73
the amount of information gathered. Therefore, if the agent is unlikely to be risk neutral (that is,
have a nonlinear utility function), then the expected utility that she would face at the time of making
her decision will be a function of her prior variance (see Table 3.1). Therefore, information gathered
would also have an effect on the expected utility of the agent in a future period through its effect on
the prior variance in future periods. As a result, she is likely to face a trade-off between the follow-
ing two choices: (a) possibly making a suboptimal decision in the current period (either keeping a
product that has a negative expected current proftability in the market or choosing a product that
has a lower expected utility in the current period) and (b) using the information thus gathered to
make more-informed decisions in the future. If the beneft of making more-informed decisions in
the future outweighs the cost of making a suboptimal decision in the current period, the agent might
deviate from the myopically optimal choice. For example, Erdem and Keane (1996) argue that a
consumer (the agent) might experiment by purchasing a product that has a lower expected utility
if she could learn about the products attributes from the purchase (and eventual consumption). This
experimentation will help her make a more informed decision in future periods.
Hitsch (2006) illustrates this point using a simple example in the context of a manager (the
agent) who has to decide whether or not to keep a new product in the market. The agents uncer-
tainty pertains to the profts the new product would generate. Let her belief about the products
per-period proftability be 1 with probability q (proftable outcome) and 1 with probability 1 q
(unproftable outcome). Therefore, the expected net present value of profts the new product would
generate over an infnite horizon would be

T T T
, (8)
where , 0 1 is the discount factor. Based on this expected proft, the agent would keep the
product in the market only if the probability of the proftable outcome q > 0.5. However, this
ignores the possibility that the agent might learn something about the products proftability by
keeping it in the market. For example, consider that the agent would learn about the true proft-
ability of the product if she keeps it in the market for one period, that is, the signal is completely
informative. In such a scenario, the product would have an expected proft of 2q 1 in the current
period (same as above). However, armed with the information regarding the true proftability of
the product, the agent can make the optimal decision in future periods. Therefore, the net present
value of the proft stream when the agent considers the fact that she could learn about the true
proftability of the product would be

T
T
. (9)
In the above expression, the frst part, 2q 1, captures the expected profts in the current
period, and the second part corresponds to the net present value of the expected profts that the
agent would derive after having learned about its true proftability. Under this scenario, the agent
would keep the product in the market as long as

>

T
. Note that

<

if > 0.
Therefore, when the discount factor, , is greater than 0, the agent could make different decisions
regarding retaining the product in the market depending on whether or not she considers the role
of learning in enabling her to make more informed decisions in future periods. Specifcally, the
decision criteria for keeping the product in the market would differ under the two scenarios for
74 S. SRIRAM AND PRADEEP K. CHINTAGUNTA
values of q that lie in the range

< <

. More intuitively, when the agent considers the role

of signals in helping her make more informed decisions in the future, the criteria for keeping the
product alive are likely to be less stringent.
Despite the strong argument in favor of formulating the agent as a forward-looking decision maker,
most of the research in learning models has focused on myopic decision makers. In some contexts such
as a physician prescribing drugs for a patient, it can be argued that the threat of malpractice lawsuits
might prevent the agent from experimenting in order to learn about the products true attributes. In
a specifc empirical context, one can look to the data to get some preliminary evidence regarding
experimentation by the agents. So, for example, when looking at new parents making decisions on
the brand of diaper to purchase for their frstborn child, one can check to see whether we observe a
lot of brand switching along with the purchase of small package sizes soon after birth, with the pat-
tern settling down to infrequent switching and larger package sizes subsequently. Such a purchase
pattern might be taken as some evidence consistent with rational forward-looking behavior on the
part of agents (see also Crawford and Shum 2005). Nevertheless, the dynamic nature of learning
models provides suffcient reason to model the agent as a forward-looking decision maker.
The Role of Forgetting
Learning models in the literature have typically assumed that the agents can perfectly recall the
information accumulated in the past. Mehta, Rajiv, and Srinivasan (2004) invoke the literature on
memory and recall (Anderson 1999; Cook and Flay 1978) to challenge this assumption. Specif-
cally, they use evidence from the social psychology literature to formulate a model wherein an
agents evaluation of an unknown entity converges to its prior value as the time between signals
increases. The basic structure of the Mehta, Rajiv, and Srinivasan (2004) model hinges on the
conjecture by Alba, Hutchinson, and Lynch (1991) that consumers (the agent) construct their
quality evaluations of products using (a) the attribute information on the products package and
(b) the information retrieved from their memory regarding their quality evaluations of the product
from past consumption experiences. In line with this theory, Mehta and his coauthors divide the
information that the consumers use to evaluate a brands quality into two groups: (a) the position-
ing set, which corresponds to the information that the consumer learns about the quality of the
brand from its advertisements and/or brand name and (b) the consumption set, which contains the
cumulative information regarding the consumers assessment of the brands true quality from her
prior consumption experiences. The consumers total evaluation of the brands quality would be a
convex combination of the information contained in these two sets. The authors further assume that
while the information contained in the positioning set remains unaltered over time, the information
in the consumption set changes as the consumer makes purchases in the category. Moreover, the
authors assume that the consumer might not be able to perfectly recall her past evaluations based
on the choice set. To accommodate this, they defne the recalled evaluation based on the choice set
as a sum of the past evaluation based on the choice set and a random term that has a zero mean.
The random term implies that the recalled evaluation based on the choice set can be higher or
lower than the actual evaluation. Furthermore, a higher variance of this random term would imply
greater forgetting, while zero variance would imply no forgetting. In order to allow this level of
forgetting to increase with time, they model the variance of the random forgetting term to be a
function of the time elapsed since the previous purchase of the brand. When consumers receive
new signals about the quality of the brand, they update the evaluation in their consumption set in
the typical Bayesian manner with the recalled evaluation taking the role of the prior. The authors
LEARNING MODELS 75
show that the standard learning model without forgetting is a nested version of their model. From
their calibration of the model using consumer purchases in the laundry detergent category, the
authors show that not accounting for forgetting would lead to biased estimates.
2
Silent Word of Mouth
The learning models discussed thus far assume that the agents observe the value of the signals they
receive. As discussed earlier, these signals could be in the form of their own experiences, advertising
exposures, or other marketing activities (such as detailing by pharmaceutical companies). Alter-
natively, the agents could also learn through word-of-mouth communication regarding the signals
received by other agents (Roberts and Urban 1988). In all these instances, the agent observes the real
value of the signals even if the signals themselves may be noisy indicators of the true value of the
unknown entity. Zhang (2006) extends this by allowing agents to observe only the discrete decisions
that other agents make as a result of the signal they receive. However, they would not observe the
signals that the other agents actually received (as would be the case in word of mouth). Zhang calls
this Silent Word of Mouth. Under silent word of mouth, the agent has to infer the distribution of
the signals that the other agents would have received based on their actions. Examples of instances
where agents make decisions based on silent word of mouth include choice of restaurants based on
the number of patrons waiting outside or watching movies based on box offce collections.
Zhang develops her model in the context of patients (agents) who are waiting in line for a suitable
kidney for transplantation. At the time of making her decision, a patient receives her own private
signal about the quality of the kidney (the unknown entity) as well as the information that all the
other patients ahead of her in the line have rejected the kidney. Since she doesnt observe the signals
received by the patients ahead of her in the line, she has to infer their signals based on their decisions
to reject the kidney. In doing so, she also needs to account for the fact that these patients would have
rejected the kidney either because they consistently received bad signals or they employed a more
stringent criterion for accepting one. Zhang shows that an implication of her model is that if two
successive patients receive identical private signals, the decision of the frst patient would have an
effect on the second patients evaluation of the kidneys quality. Specifcally, while an acceptance by
the frst agent would increase the second agents expected evaluation, a rejection would decrease it.
As a result, patients toward the end of the line are more likely to turn down the kidney offer. Zhang
notes that, given the shortage of available kidneys for transplantation and the clinically acceptable
quality of most rejected kidneys, this fnding could have implications for policy makers. In particular,
facilitation of word-of-mouth communication between patients and suppression of observational
learning might be two mechanisms to break the sequential nature of the decision process.
Avenues for Future Research
In this section, we discuss several possible extensions of the learning literature. Broadly, we group
them into three categories: (a) biased signals, (b) changing value of the unknown entity, and (c)
integration of Bayesian and alternative learning mechanisms.
Biased Signals
Learning models typically assume that although the signals received by the agents are likely
to be noisy, they are nevertheless unbiased. Therefore, if one were to take the average (across
agents and time) of these signals, it would equal the true value of the unknown entity. This
76 S. SRIRAM AND PRADEEP K. CHINTAGUNTA
assumption is likely to be true when consumers learn about the true quality of a product via
consumption experiences or when managers infer the true attractiveness of a market based on
observed demand. However, this assumption is likely to be violated in instances where the
signal comes from a non-neutral entity. For example, advertising or detailing signals by frms
are likely to place a greater emphasis on the positive aspects of their products. Likewise, infor-
mation reported in news outlets with political leanings are likely to be biased in favor of their
respective ideologies (Gentzkow and Shapiro 2008). It would thus be worthwhile to extend the
literature to accommodate learning in the presence of such biased signals. If agents are indeed
aware of the biased nature of signals, they are likely to discount positive claims and/or place
greater emphasis on the negative ones.
Time-Varying Values of the Unknown Entity
While most of the Bayesian learning literature in marketing has assumed that the value of the
unknown entity remains unchanged over time, one can envision scenarios where this is not true.
One such scenario is when the true value of the unknown entity fuctuates stochastically around
a constant mean (see, for example, Lovett 2008). Under such a scenario, the agent knows that the
true value of the unknown entity varies stochastically from time to time as follows:

W W W
4 4 + =

,
a

1
W
, (10)
where Q
t
is the true value of the unknown entity at time t and
t
is its stochastic variation at time
t. Since the mean of this stochastic variation is zero, the true value of the unknown entity fuctu-
ates around a constant mean. Note that the agent does not observe the true value of the unknown
entity, Q
t
. However, the consumer knows the temporal fuctuation in the true value of the unknown
entity, a

1
W
. The consumer, therefore, observes a noisy measure of the unknown entity
such that

a

4 W (LW
4 1 4
, , L 7 W = = . (2)
Thus, the only difference between equations 2 and 2 is that in the latter, the process that
generates the signals varies over time. Therefore, when the agent receives signals that vary
over time, it could be either because of (a) noise in the signal generating process,

4
, or (b)
the temporal variation in the signal generating process,
t
. Taken together, equations 10 and 2
represent the system of equations in a standard Kalman flter (Kalman 1960) with equation 2
playing the role of the observation (or measurement) equation and equation 10 acting as the
system (or state) equation. Hence, the agents updating mechanism can be readily obtained based
on derivation of the standard Kalman flter (see, for example, Hamilton 1994; Meinhold and
Singpurwalla 1983; West and Harrison 1994 for simple exposition of the derivation). In what
follows, we present an intuitive discussion of the implications of this stochastic fuctuation. Once
again, we note that equation 2 is similar to equation 2, with the exception that the mean of the
process that generates the signals is time varying. An implication of this temporal fuctuation
is that as the agent receives signals and updates her belief about the true value of the unknown
entity, she also needs to consider this fuctuation. As a result, the agents posterior belief at the
end of period t1 and her prior belief at the beginning of period t will not coincide.
3
Since the
mean of the fuctuation is zero, the posterior mean at the end of period t1 and the prior mean
LEARNING MODELS 77
at the beginning of period t would remain the same. On the other hand, this will not be the
case for the posterior and prior variances. Specifcally, if the posterior variance that the agent
i perceives about the true value of the unknown entity at the end of period t is

_ W LW
, then her
prior variance at the beginning of period t is


_

_
+ =
W LW W LW
.
(11)
Hence, the variance of the stochastic fuctuation,

, is added to the posterior variance at the

end of period t1 in arriving at the uncertainty that the agent perceives about the true value of
the unknown entity at the beginning of period t. The intuition behind the above equation is that
the stochastic fuctuation increases the uncertainty that an agent would perceive about the true
quality of the product. As discussed subsequently, it can be shown that when agents anticipate
such stochastic fuctuations in the true value of the unknown entity, the rate of reduction of the
perceived uncertainty (posterior variance) would be slower than it would be if the true value were
time invariant.
One can augment the temporal evolution discussed above to allow the mean of the true value
of the unknown entity to evolve over time. In a simple extension of equation 10, the true value of
the unknown entity can evolve such that

W W W
4 4 + =

, a

1
W
. (10)
Thus, if 0 < < 1 and Q
t
> 0, then the true value of the unknown entity would decrease sto-
chastically over time. An implication of the temporal variation in the mean is that both the prior
mean and the prior variance at the beginning of period t would differ from their corresponding
posteriors at the end of period t1. More formally,

_ _
=
W LW W LW
4 4 ,
(12)


_

_
+ =
W LW W LW
,
(13)
where,
_ W LW
4 and

_ W LW
are the posterior mean and variance at the end of period t1 and
_ W LW
4
and

_ W LW
is the prior mean and variance at the beginning of period t. Furthermore, equations 3a,
3b, 3c, and 3d can be rewritten as follows:

(LW LW W LW LW W LW
4 4 4 + =
_ _
,
(3a)


_

_


4
LW
W LW
W LW
,

+
=

,
(3b)


_

4 W W L LW
4
4
LW
W W L
W W L
LW
,
,

+
=
+
=

,
(3c)
78 S. SRIRAM AND PRADEEP K. CHINTAGUNTA


_

_

_

4 W W L LW
W W L LW
4
LW
W W L
4
LW
LW
,
,
,
,

+
=
+
=

. (3d)
The above formulation can be extended to accommodate the evolution of the true value of
the unknown entity, Q
t
, as a function of other covariates (see, for example, Akcura, Gonul, and
Petrova 2004).
Notwithstanding the mathematical formulation of the belief updating process, the follow-
ing question arises: how is this evolution identifed? For example, consider the case where
the mean of the unknown entity does not vary over time. Under such a scenario, how can one
separately identify fuctuations in the delivery mechanism of the unknown entity from the
temporal fuctuations in its true value? There are two arguments that favor this identifcation.
First, in the absence of the stochastic temporal variation, the weight that the agent places on
the realized values of the unknown entity,
it
, would steadily decrease over time and asymp-
totically tend to zero. On the other hand, in the presence of a stochastic fuctuation in the true
value of the unknown entity, the weight would decrease at a slower rate and asymptote to a
value greater than zero. As in Lovett (2008), we plot the evolution of this weight for different
values of s
2

/s
2
Q
in Figure 3.2. From this fgure, it is evident that for the traditional Bayesian
learning model with no stochastic fuctuation in the true value (s
2

/s
2
Q
= 0), the weight,
it
,
approaches zero. However, as the stochastic fuctuation gets more pronounced and s
2

/s
2
Q

increases, the weight asymptotes away from zero. Therefore, if one had a suffciently large
time series of observations, the extent to which the weight asymptotes away from zero can
be used to infer the variance of the stochastic fuctuation, s
2

. The second argument in favor

of identifcation is based on the fact that if the true value of the unknown entity does not vary
over time, the underlying distribution of an agents beliefs should remain unaltered over time
if she does not receive any signals. On the other hand, if the agent expects temporal fuctua-
tions in the true value of the unknown entity, her beliefs would exhibit changes even in the
absence of signals. Hence, to the extent that one observes fuctuations in an agents prior
beliefs (variance when there is only stochastic variation, and both mean and variance when
there is both change in mean and stochastic variation) across several periods when she does
not receive signals, the model parameters can be identifed.
Despite the possible richness of a model that allows for temporal variations in the true value
of the unknown entity and the arguments behind identifcation of such a model, there has been
very limited empirical work. It would hence be worthwhile to extend the literature along these
lines. Moreover, it would be worthwhile to construct structural versions of reduced form models
based on the Kalman flter.
Alternatives and Augmentations to Bayesian Learning
While most of the discussion in this chapter has revolved around Bayesian learning by agents,
alternative learning mechanisms as well as augmentations to Bayesian learning are possible. In this
regard, it might be worthwhile to integrate the rich theories in the psychology as well as behavioral
marketing literatures with the extant state of the art in Bayesian learning. We believe that there
are at least three possible avenues to doing this. First, an implication of Bayesian learning is that
an agents belief about the entity she is uncertain about does not depend on the order in which
LEARNING MODELS 79
she receives information (or signals). However, experimental evidence suggests otherwise (see,
for example, Hogarth and Einhorn 1992). It would thus be useful to develop alternative learning
models that account for order effects in belief updating. Second, when agents receive signals about
the entity they are uncertain about, these signals can exhibit either positive or negative deviations
from what they expected based on their beliefs. In a standard model of Bayesian updating, both
positive and negative deviations are given equal weight. However, according to prospect theory
(Kahneman and Tversky 1979), agents tend to place a greater emphasis on negative deviations
than they would on positive ones, that is, losses loom larger than gains. Integrating such asym-
metric weighting into a model of Bayesian updating would be a worthwhile extension. Third,
although Bayesian learning has been very popular in the marketing literature, consumers might
use several other heuristics while making decisions as well as in updating their beliefs (Tversky
and Kahneman 1974). Extensions that accommodate these heuristics might be worthwhile addi-
tions to the literature.
Although these extensions will help us better understand the mechanism that agents use to
update their beliefs about an unknown entity, the data requirements to facilitate the identifcation
of such augmented models is likely to be stringent. Most of the alternative learning mechanisms
as well as heuristics used in decision-making have been tested using experimental data. On the
other hand, most of the empirical work on Bayesian learning has used secondary data sources.
Hence, researchers need to be cognizant of the additional data requirements that might be needed
to model alternative learning mechanisms.
Conclusion
In this chapter, we present a critical review of learning models in the marketing literature. We
also discuss some avenues in which the literature can be extended to accommodate more realistic
Figure 3.2 Weight Placed on Current Information Over Time
0.0
0.2
0.4
0.6
0.8
1.0
1.2
1 2 3 4 5 6 7 8 9 10
No. Signals
()sq/ (Q)sq=0 ()sq/ (Q)sq=0.6
()sq/ (Q)sq=1 ()sq/ (Q)sq=1.4
80 S. SRIRAM AND PRADEEP K. CHINTAGUNTA
behavior by agents. Since learning models discussed in this literature are structural in nature, they
provide a basis for examining the effect of structural changes in marketing variables on the behavior
of agents. We believe that this stream of research provides suffcient grounds to conduct future
research that would be interesting to academics and practitioners alike. We hope that this literature
review would provide the basic building blocks and a consolidated overview for researchers who
seek to push the frontiers of knowledge in this area.
Notes
1. Note that in typical random utility models, the presence of the error term
it
implies randomness from
the perspective of the researcher and not the consumer. In other words,
it
is fully known to the consumer.
2. Gowrisankaran, Ho, and Town (2006) consider the situation where doctors learn about complicated
heart surgery procedures by performing them on many patients. In their model, they allow these doctors to
forget what they have learned over time if they do not practice the procedure. However, their application
does not use a Bayesian learning model.
3. Since the mean of the fuctuation is zero, the posterior mean at the end of period t1 and the period
mean at the beginning of period t would remain the same.
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