Loss aversion and the quantity–quality tradeoff

Firms face an optimization problem that requires a maximal quantity output given a quality constraint. But how do firms incentivize quantity and quality to meet these dual goals, and what role do behavioral factors, such as loss aversion, play in the tradeoffs workers face? We address these questions with a theoretical model and an experiment in which participants are paid for both quantity and quality of a real effort task. Consistent with basic economic theory, higher quality incentives encourage participants to shift their attention from quantity to quality. However, we also find that loss averse participants shift their attention from quality to quantity to a greater degree when quality is weakly incentivized. These results can inform managers of appropriate ways to structure contracts, and suggest benefits to personalizing contracts based on individual behavioral characteristics.     

Pricing and Product Positioning with Relative Consumer Preferences*

Frequent price promotions force consumers to continuously reassess their preferences over product offerings. When this leads consumers to exhibit a bias of “relative thinking”, such as may be triggered by a focus only on the most salient product attribute, we show in a model of sales (Varian, H. R., 1980, American Economic Review, 70(4), pp. 651–659) that this profoundly alters firms' pricing and product-positioning strategies. Vertical differentiation becomes more likely, with firms preferring to occupy the low-quality space in particular when they have few loyal consumers. More generally, product positioning now depends on the composition of consumers' consideration sets.     

EXCESSIVE COMPETITION ON HEADLINE PRICES

In a variety of purchasing situations, consumers may focus primarily on headline prices, disregarding the full costs associated with acquiring and maintaining a product or service contract. Even when this is the case, the literature has delineated various circumstances where intense competition can protect consumers through the so-called “waterbed effect.” In this article, we however show that when consumers have context-dependent preferences, competition may rather exacerbate their and society's harm by distorting product choice and provision. Then, consumer protection policy must sufficiently constrain hidden fees so that competition, along with high-quality firms' incentives to educate consumers, can restore efficiency.