Loss Aversion , Price Stability , and Sales ∗

A large body of experimental evidence suggests that people are loss averse. Inspired by this evidence, we develop a model in which a monopolist 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 monopolist chooses to smooth out small cost shocks, endogenously giving rise to a kinked demand curve. Whether or not the firm smoothes out small cost shocks, it has an incentive to set countercyclical markups. Despite this tendency towards " price stickiness, " we also show that a multi-product monopolist who faces stable production costs can have an incentive to set random prices. Our model can therefore explain the seemingly paradoxical evidence of price stability and sales within a single framework. * We will thank lots of people at some stage.