Behavioral consumer theorySlide 2Loss-aversion & pricing (Heidhues & Koszegi, 04)Behavioral consumer theoryBehavioral consumer theoryHow should firms profit-max with behavioral How should firms profit-max with behavioral consumers?consumers?Procrastinating consumersProcrastinating consumersBlockbuster…huge profit from late fees, forecasting error + Blockbuster…huge profit from late fees, forecasting error + loss-aversion?loss-aversion?Credit card “teaser rates” (Ausubel AER 91?)Credit card “teaser rates” (Ausubel AER 91?)Only 70% pay off balance, average household balance $5,000Only 70% pay off balance, average household balance $5,000Netflix– pay a monthly fee for movies…but don’t get around Netflix– pay a monthly fee for movies…but don’t get around to watching them! to watching them!  Per movie fee may be large Per movie fee may be largeHealth clubs (Della Vigna & Malmendier, 04)Health clubs (Della Vigna & Malmendier, 04)Pay $17/visit through annual fees vs $10/visitPay $17/visit through annual fees vs $10/visitBehavioral consumer theoryBehavioral consumer theoryHow should firms behave with lifelike consumers? IIHow should firms behave with lifelike consumers? IIPrice discrimination through impatiencePrice discrimination through impatienceDiscriminate by demand based on impatienceDiscriminate by demand based on impatienceMovie openings (Star Wars)Movie openings (Star Wars)Similar to conventional price discrimination but comes from Similar to conventional price discrimination but comes from ββ--δδ??RebatesRebatesConsumers plan to cash in rebates, only 15% do soConsumers plan to cash in rebates, only 15% do soPricing illusionsPricing illusions “ “10 CD’s for $.01”…relies on laziness in sending back 10 CD’s for $.01”…relies on laziness in sending back CD’s+shipping feesCD’s+shipping feesWhen does competition eliminate behavioral demand When does competition eliminate behavioral demand effects? effects? A: Depends on consumer forecasting of future mistakesA: Depends on consumer forecasting of future mistakesIs there more profit in exploiting mistakes or correcting Is there more profit in exploiting mistakes or correcting mistakes?mistakes?Political regulation vs firm competition to help consumersPolitical regulation vs firm competition to help consumersE.g., “cooling off” laws, price gouging, class action (Blockbuster)E.g., “cooling off” laws, price gouging, class action (Blockbuster)Loss-aversion & pricingLoss-aversion & pricing (Heidhues & Koszegi, 04)(Heidhues & Koszegi, 04)Personal equilibriumPersonal equilibrium (Rabin & Koszegi 04):(Rabin & Koszegi 04):Consumers create reference point (matches expected purchase)Consumers create reference point (matches expected purchase)Loss-averse (Loss-averse (λλ) toward loss of money or goods (value v)) toward loss of money or goods (value v)TimingTimingFirms …….consumer………price p, cost Firms …….consumer………price p, cost c….shock………………………..c….shock………………………..pick F(p)…forms beliefs……..realized…………………….consumer pick F(p)…forms beliefs……..realized…………………….consumer buysbuysShock h(w) to consumer value unique-fies demand (Prop Shock h(w) to consumer value unique-fies demand (Prop 2)2)Price stickiness (Prop 3)Price stickiness (Prop 3)For substantial loss-aversion, firms choose discrete pricesFor substantial loss-aversion, firms choose discrete pricesPrices don’t vary smoothly with cost c (surprising)Prices don’t vary smoothly with cost c (surprising)““menu costs” empirics, Kayshap et al QJE 02?menu costs” empirics, Kayshap et al QJE 02?Intuition: At a price p, consumers dislike foregoing a lower price; Intuition: At a price p, consumers dislike foregoing a lower price; incentivizes firms to lump prices togetherincentivizes firms to lump prices togetherCf. “kinked” demand curve (1930’s econ) to explain sticky prices…but Cf. “kinked” demand curve (1930’s econ) to explain sticky prices…but in this model it is derived in this model it is derived endog eneouslyendog eneouslyCountercyclical markups (shrink in booms, grow in busts)Countercyclical markups (shrink in booms, grow in busts)Explains puzzle of fixed consumer prices and wagesExplains puzzle of fixed consumer prices and wages shortages in shortages in recession, excess supply in boomsrecession, excess supply in