Tariff Choice with Consumer Learning and Switching Costs

42 Pages Posted: 27 Feb 2006 Last revised: 15 Oct 2010

See all articles by Ronald L. Goettler

Ronald L. Goettler

University of Rochester - Simon School of Business

Karen Clay

Carnegie Mellon University - H. John Heinz III School of Public Policy and Management; National Bureau of Economic Research (NBER)

Date Written: October 11, 2010

Abstract

Consumers choosing flat-rate contracts tend to have insufficient usage to warrant the cost, particularly for new products. We propose and estimate a Bayesian learning model of tariff and usage choice that explains this "flat-rate bias'' without relying on behavioral misjudgments or tariff-specific preferences. For new products, consumers are uncertain about both their utility relative to the population mean and the mean itself. This latter uncertainty inflates prior variances, which leads consumers to weight their private signals more heavily when updating beliefs. Posteriors are unbiased across products. For a given product, however, the unknown mean yields a "winner's curse'': consumers with high posteriors tend to overestimate their utility. These consumers choose fixed-rate tariffs and lower their usage as they correct their beliefs. The flat-rate bias arises when switching costs deter them from changing tariffs. Using the estimated model, we find tariff menus are ineffective screening devices for price discrimination by an online grocer. Predicted revenues increase by 20 percent when the per-use tariff is dropped, since more consumers choose and stay with the flat rate.

Keywords: consumer learning, price discrimination, dynamic discrete choice

JEL Classification: D12, D83, L12, L15

Suggested Citation

Goettler, Ronald L. and Clay, Karen B., Tariff Choice with Consumer Learning and Switching Costs (October 11, 2010). Available at SSRN: https://ssrn.com/abstract=885573 or http://dx.doi.org/10.2139/ssrn.885573

Ronald L. Goettler (Contact Author)

University of Rochester - Simon School of Business ( email )

Rochester, NY 14627
United States

Karen B. Clay

Carnegie Mellon University - H. John Heinz III School of Public Policy and Management ( email )

Pittsburgh, PA 15213-3890
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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