Inter-temporal Price Discrimination with Time-inconsistent Consumers

Abstract:     
This paper analyzes the inter-temporal price discrimination problem of a durable good monopolist facing time-inconsistent consumers. We look at both cases of sophisticated and naive time-inconsistent consumers, but the
emphasis is on the naive case. When consumers are naive, we first need to confront the following question: how does the consumers' naivete about their preferences interact with their ability to predict future prices? We solve the game under two solution concepts. Under the first solution concept, which is similar in spirit to the SPNE, consumers have correct expectations about future prices. Under the second one, which relies on backwards induction, consumers' naive expectations concerning their future preferences lead them to have incorrect expectations about future prices. We show that under both solution concepts, as the degree of naivete rises, monopoly profits fall. The monopolist does not benefit from consumers' naivete and should instead educate naive consumers into sophisticated ones. Moreover, as the degree of naivete rises, both solution concepts predict that welfare falls for all consumers, except for the highest valuation ones, and prices approach marginal cost at a lower rate.

Number of Pages in PDF File: 35

Keywords: inter-temporal price discrimination, time inconsistent preferencesm, bounded rationality and industrial organization

JEL Classification: D91, D42, C72

working papers series