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.
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Financial support from ERC grant no. 230251 and the ESRC (UK) is gratefully acknowledged. I thank Ayala Arad, Martin Cripps, Eddie Dekel, Kfir Eliaz, Yves Guéron, Paul Heidhues, Botond Kőszegi, Ariel Rubinstein, the editor of this journal and two anonymous referees, for helpful comments.
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Spiegler, R. Monopoly pricing when consumers are antagonized by unexpected price increases: a “cover version” of the Heidhues–Kőszegi–Rabin model. Econ Theory 51, 695–711 (2012). https://doi.org/10.1007/s00199-011-0619-5
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DOI: https://doi.org/10.1007/s00199-011-0619-5