More than a Penny's Worth: Left-Digit Bias and Firm Pricing

Abstract

Why do so many prices end with 99 cents? Firms arguably price at 99-ending prices because of left-digit bias, the tendency of consumers to perceive a $4.99 as much lower than $5.00. Using retail scanner data on thousands of products and dozens of retailers, I provide reduced-form support for this explanation. I then structurally estimate the magnitude of left-digit bias, and find that consumers respond to a 1-cent increase from a 99-ending price as if it were a 15-25 cent increase. Next, I analyze how firms should respond to left-digit biased demand. I solve and estimate a model that makes three key predictions: (1) prices should bunch at 99-ending prices; (2) there should be ranges of missing prices with low price-endings; (3) these ranges of missing prices should increase with the dollar digit. Qualitatively, these predictions hold. Firms respond to the bias with high shares of 99s and missing low-ending prices. Quantitatively, however, firms price as if the bias were much smaller and demand were more elastic, so they use dominated prices. I estimate that the retailer is forgoing 1-3 percents of potential gross profits due to this misperception.

JEL Classification: D90, D12, D22, L11, L20, L81