The impact of consumer loss aversion on pricing

We develop a model in which a profit-maximizing monopolist with uncertain cost of production sells to loss-averse, yet rational, consumers. We first introduce (portable) techniques for analyzing the demand of such consumers, and then investigate the monopolist’s pricing strategy. In contrast to the standard monopoly model, we find that in relatively stable environments, the firm chooses a discrete price distribution, endogenously giving rise to a kinked demand curve. A low price responsiveness of demand and a high frequency of purchase by consumers also promote such “price stickiness”. Whether or not the monopolist’s prices are sticky, markups follow a countercyclical pattern. Despite this tendency toward price stability, there are also circumstances in which a firm with unchanging cost offers random “sales” to attract more demand at higher prices.