Behavioral consumer theory How should firms profit-max with behavioral consumers? Procrastinating consumers Blockbuster…huge profit from late fees, forecasting error + loss-aversion? Credit card “teaser rates” (Ausubel AER 91?) Only 70% pay off balance, average household balance $5,000 Netflix– pay a monthly fee for movies…but don’t get around to watching them!  Per movie fee may be large Health clubs (Della Vigna & Malmendier, 04) Pay $17/visit through annual fees vs $10/visit

Behavioral consumer theory How should firms behave with lifelike consumers? II Price discrimination through impatience Discriminate by demand based on impatience Movie openings (Star Wars) Similar to conventional price discrimination but comes from β-δ? Rebates Consumers plan to cash in rebates, only 15% do so Pricing illusions “10 CD’s for $.01”…relies on laziness in sending back CD’s+shipping fees When does competition eliminate behavioral demand effects? A: Depends on consumer forecasting of future mistakes Is there more profit in exploiting mistakes or correcting mistakes? Political regulation vs firm competition to help consumers E.g., “cooling off” laws, price gouging, class action (Blockbuster)

Loss-aversion & pricing (Heidhues & Koszegi, 04) Personal equilibrium (Rabin & Koszegi 04): Consumers create reference point (matches expected purchase) Loss-averse (λ) toward loss of money or goods (value v) Timing Firms …….consumer………price p, cost c….shock……………………….. pick F(p)…forms beliefs……..realized…………………….consumer buys Shock h(w) to consumer value unique-fies demand (Prop 2) Price stickiness (Prop 3) For substantial loss-aversion, firms choose discrete prices Prices don’t vary smoothly with cost c (surprising) “menu costs” empirics, Kayshap et al QJE 02? Intuition: At a price p, consumers dislike foregoing a lower price; incentivizes firms to lump prices together Cf. “kinked” demand curve (1930’s econ) to explain sticky prices…but in this model it is derived endogeneously Countercyclical markups (shrink in booms, grow in busts) Explains puzzle of fixed consumer prices and wages shortages in recession, excess supply in booms