Consumer Fairness Concerns and Dynamic Pricing in a Channel

Abstract

The extant literature has well documented consumers’ fairness concerns. For example, when a firm charges a higher price than what’s considered fair (a reference point), some consumers may experience some psychological disutility when buying from the firm. This paper studies a channel where the retailer faces a segment of consumers who have fairness concerns about retail price increases. We analyze a growing market where, in each of the two periods, the manufacturer sells its product at a wholesale price to the retailer, which chooses its retail prices dynamically. However, if the retailer raises its second-period price, the second-period demand will experience a drop in the segment of consumers with fairness concerns. Our analysis reveals several interesting findings. First, the presence of consumers with fairness concerns tends to make the manufacturer increase its first-period wholesale price and reduce its second-period wholesale price. Second, the presence of consumers with fairness concerns can in equilibrium reduce both the first-period and second-period retail prices. Third, an increase in the market growth rate can lead to a decrease in retail and wholesale prices in both periods. Fourth, consumer fairness concerns can result in an all-win situation for the manufacturer, the retailer, and the consumers. The existence of a segment of consumers with fairness concerns can allow the retailer to lower its first-period price, which in essence helps the retailer to commit to not significantly raising its second-period price, which in turn gives the manufacturer an incentive to lower its second-period wholesale price, making pricing in the channel more efficient.

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

JEL Classification: M31, D21