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Competition and Price Variation When Consumers Are Loss Averse

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Author Info
Paul Heidhues
Botond Koszegi

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Abstract

We modify the Salop (1979) model of price competition with differentiated products by assuming that consumers are loss averse relative to a reference point given by their recent expectations about the purchase. Consumers' sensitivity to losses in money increases the price responsiveness of demand—and hence the intensity of competition—at higher relative to lower market prices, reducing or eliminating price variation both within and between products. When firms face common stochastic costs, in any symmetric equilibrium the markup is strictly decreasing in cost. Even when firms face different cost distributions, we identify conditions under which a focal-price equilibrium (where firms always charge the same "focal" price) exists, and conditions under which any equilibrium is focal. (JEL D11 , D43, D81, L13)

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File URL: http://hdl.handle.net/10.1257/aer.98.4.1245
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Publisher Info
Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 98 (2008)
Issue (Month): 4 (September)
Pages: 1245-68
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Handle: RePEc:aea:aecrev:v:98:y:2008:i:4:p:1245-68

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  1. Botond Koszegi & Matthew Rabin, 2005. "A Model of Reference-Dependent Preferences," Levine's Bibliography 784828000000000341, UCLA Department of Economics. [Downloadable!]
  2. Fabian Herweg & Daniel Müller & Philipp Weinschenk, 2008. "The Optimality of Simple Contracts: Moral Hazard and Loss Aversion," Bonn Econ Discussion Papers bgse17_2008, University of Bonn, Germany. [Downloadable!]
  3. Julio J. Rotemberg, 2009. "Altruistic Dynamic Pricing with Customer Regret," NBER Working Papers 14933, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Jozsef Sakovics, 2007. "Reference price distortion," ESE Discussion Papers 177, Edinburgh School of Economics, University of Edinburgh. [Downloadable!]
  5. Andreas Lange & Andrew Stocking, 2009. "Charitable Memberships, Volunteering, and Discounts: Evidence from a Large-Scale Online Field Experiment," NBER Working Papers 14941, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  6. Di Tella, Rafael & Dubra, Juan, 2008. "Anger and Regulation," MPRA Paper 14442, University Library of Munich, Germany, revised 29 Mar 2009. [Downloadable!]
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