Consumer Fairness Concerns and Dynamic Pricing in a Channel

Abstract

The extant literature has shown that when a firm increases its price due to increased demand or consumer valuation, some consumers may have fairness concerns and experience psychological disutility when buying the firm’s product. This paper provides a two-period model to study the effects of consumers’ fairness concerns on firms’ dynamic pricing strategies and profits in a channel. Our analysis reveals a strategic link between the two periods—the retailer has a cost-reduction incentive of lowering its first-period price to induce the manufacturer to reduce the wholesale price in the second period. When the retailer’s cost-reduction incentive prevails, in equilibrium, the retail price stays unchanged while the wholesale price decreases over time. Hence, our results provide an alternative explanation for the empirical observation that retail prices typically do not decrease when wholesale prices do (Anderson et al. 2015). Further, we find that a higher demand increase in the second period can lead to a decrease in both wholesale and retail prices. Importantly, we show that consumer fairness concerns can result in a win-win outcome for the manufacturer and the retailer, which suggests that firms may prefer not using tactics such as price framing to alleviate fairness concerns.

Keywords: fairness, behavioral economics, dynamic pricing, channel, double marginalization

JEL Classification: M31, D21