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Monopoly pricing when consumers are antagonized by unexpected price increases: a “cover version” of the Heidhues–Kőszegi–Rabin model

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  • Ran Spiegler

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Abstract

This paper reformulates and simplifies a recent model by Heidhues and Kőszegi (The impact of consumer loss aversion on pricing, Mimeo, 2005 ), which in turn is based on a behavioral model due to Kőszegi and Rabin (Q J Econ 121:1133–1166, 2006 ). The model analyzes optimal pricing when consumers are loss averse in the sense that an unexpected price hike lowers their willingness to pay. The main message of the Heidhues–Kőszegi model, namely that this form of consumer loss aversion leads to rigid price responses to cost fluctuations, carries over. I demonstrate the usefulness of this “cover version” of the Heidhues–Kőszegi-Rabin model by obtaining new results: (1) loss aversion lowers expected prices; (2) the firm’s incentive to adopt a rigid pricing strategy is stronger when fluctuations are in demand rather than in costs. Copyright Springer-Verlag 2012

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File URL: http://hdl.handle.net/10.1007/s00199-011-0619-5
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Bibliographic Info

Article provided by Springer in its journal Economic Theory.

Volume (Year): 51 (2012)
Issue (Month): 3 (November)
Pages: 695-711

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Handle: RePEc:spr:joecth:v:51:y:2012:i:3:p:695-711

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Related research

Keywords: Loss aversion; Monopoly pricing; Cover version; D03; D42;

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References

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  1. Pascal Courty & Mario Pagliero, 2006. "Price Variation Antagonism and Firm Pricing Policies," Economics Working Papers ECO2006/27, European University Institute.
  2. Ran Spiegler, 2006. "The Market for Quacks," Review of Economic Studies, Oxford University Press, vol. 73(4), pages 1113-1131.
  3. Botond Koszegi & Matthew Rabin, 2004. "A Model of Reference-Dependent Preferences," Method and Hist of Econ Thought 0407001, EconWPA.
  4. Osborne, M-J & Rubinstein, A, 1997. "Games with Procedurally Rational Players," Papers 4-97, Tel Aviv.
  5. Karle, Heiko & Peitz, Martin, 2010. "Pricing and Information Disclosure in Markets with Loss-Averse Consumers," CEPR Discussion Papers 7785, C.E.P.R. Discussion Papers.
  6. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  7. Ernst Fehr & Lorenz Goette & Christian Zehnder, 2008. "A behavioral account of the labor market: the role of fairness concerns," IEW - Working Papers 394, Institute for Empirical Research in Economics - University of Zurich.
  8. Kahneman, Daniel & Knetsch, Jack L & Thaler, Richard, 1986. "Fairness as a Constraint on Profit Seeking: Entitlements in the Market," American Economic Review, American Economic Association, vol. 76(4), pages 728-41, September.
  9. Heidhues, Paul & Köszegi, Botond, 2005. "The Impact of Consumer Loss Aversion on Pricing," CEPR Discussion Papers 4849, C.E.P.R. Discussion Papers.
  10. Spiegler, Ran, 2011. "Bounded Rationality and Industrial Organization," OUP Catalogue, Oxford University Press, number 9780195398717.
  11. Gadi Fibich & Arieh Gavious & Oded Lowengart, 2007. "Optimal price promotion in the presence of asymmetric reference-price effects," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 28(6), pages 569-577.
  12. Botond Kőszegi & Paul Heidhues, 2008. "Competition and Price Variation When Consumers Are Loss Averse," American Economic Review, American Economic Association, vol. 98(4), pages 1245-68, September.
  13. Belleflamme,Paul & Peitz,Martin, 2010. "Industrial Organization," Cambridge Books, Cambridge University Press, number 9780521681599, October.
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Cited by:
  1. Ahrens, Steffen & Pirschel, Inske & Snower, Dennis J., 2014. "A theory of price adjustment under loss aversion," Economics Working Papers 2014-05, Christian-Albrechts-University of Kiel, Department of Economics.
  2. Rosato, Antonio, 2013. "Selling Substitute Goods to Loss-Averse Consumers: Limited Availability, Bargains and Rip-offs," MPRA Paper 47168, University Library of Munich, Germany.

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