Does Loss Aversion Preclude Price Variation?

Abstract

In modern retailing, frequent discounts are seemingly at odds with the idea that price variation antagonizes loss-averse consumers and hence diminishes their demand for products and services. We model a monopolist selling a product over time to loss-averse consumers who differ in their sensitivity to losses. Although the market is thus segmented, the firm cannot price-discriminate among consumers based on that sensitivity. We show that charging a long-run constant price may be suboptimal and then derive conditions under which the optimal policy is cyclic (e.g., a periodic markdown policy). These findings establish that loss aversion does not preclude price variation and thereby underscore the importance of incorporating consumer heterogeneity into pricing policies.

Keywords: behavioral pricing, loss aversion, cyclic pricing, markdown management, retailing