Working Paper: CEPR ID: DP15967
Authors: Heiko Karle; Heiner Schumacher; Rune Volund
Abstract: We consider a model of Bertrand competition where consumers are uncertain about thequalities and prices of firms' products. Consumers can inspect all products at zero cost.A share of consumers is expectation-based loss averse. For these consumers, a purchaseplan, which involves buying products of varying quality and price with positive probability,creates scale-dependent disutility from gain-loss sensations. Even if their degreeof loss aversion is modest, they may refrain from inspecting all products and choose anindividual default that is first-order stochastically dominated. Firms' strategic behaviorcan exacerbate the scope for this "uncertainty effect", and sellers of inferior products mayearn positive profits despite Bertrand competition. We find suggestive evidence for thepredicted association between consumer behavior and loss aversion in new survey data.
Keywords: consumer search; competition; loss aversion
JEL Codes: D21; D83; L41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| loss aversion (G41) | consumer search behavior (D12) |
| consumer search behavior (D12) | forgoing advantageous contracts (L14) |
| loss aversion (G41) | higher prices (D49) |
| loss aversion (G41) | reduced consumer surplus (D11) |
| firms targeting loss averse consumers (G41) | positive profits (D33) |
| loss averse consumers (D11) | preference for inferior default option (D01) |