Selling to Overconfident Consumers
Michael D. Grubb
Massachusetts Institute of Technology (MIT) - Economics, Finance, Accounting (EFA)
May 2, 2008
Consumers may overestimate the precision of their demand forecasts. This overconfidence creates an incentive for both monopolists and competitive firms to offer tariffs with included quantities at zero marginal cost, followed by steep marginal charges. This matches observed cell-phone service pricing plans in the US and elsewhere. An alternative explanation with common priors can be ruled out in favor of overconfidence based on observed customer usage patterns for a major US cellular phone service provider. The model can be reinterpreted to explain the use of flat rates and late fees in rental markets, and teaser rates on loans. Nevertheless, firms may benefit from consumers losing their overconfidence.
Number of Pages in PDF File: 50
Keywords: overconfidence, screening, nonlinear pricing, three-part tariff, cellular, telecommunications
JEL Classification: D4, D8, L1working papers series
Date posted: May 17, 2005 ; Last revised: September 24, 2009
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