Complex Pricing and Consumer Behavior: Evidence from a Lab Experiment

Joshua Deutschmann (University of Wisconsin)
Jeffrey Michler (University of Arizona)
Emilia Tjernstrom (University of Sydney)

Abstract : Multi-product firms are increasingly engaged in the targeting of consumers using complex pricing models. Bundling is one such pricing strategy that theory suggests should increase firm profits. However, many of these models fail to account for how real consumers may struggle to fully optimize when faced with such complex price menus. We conduct a lab experiment to explore how consumers may fall short of optimal decision-making under increasingly complex pricing menus. We then randomly introduce additional cognitive load to explore how external stress may exacerbate the effects of complex pricing. Finally, we show how firms might account for these results in choosing a more streamlined pricing strategy.

Optimal Payment Contracts in Trade Relationships

Christian Fischer (University of Bayreuth)

Abstract : Trade credit is one of the most important sources of short-term finance in buyer-seller transactions. This paper studies a seller's trade credit provision decision in a situation of repeated contracting with incomplete information over the buyer's ability and willingness of payment compliance when the enforceability of formal contracts is uncertain. We show that selecting the payment terms of a transaction corresponds to managing an inter-temporal trade-off between improving the quality of information acquisition and mitigating relationship breakdown risks. The dynamically optimal sequence of payment contracts can be uniquely determined provided that the quality of contract enforcement institutions is sufficiently low.

Auto Dealer Loan Intermediation: Consumer Behavior and Competitive Effects

Andreas Grunewald (Frankfurt School of Finance and Management)
David Low (Consumer Financial Protection Bureau)
Jonathan Lanning (Federal Reserve Bank of Chicago)
Tobias Salz (MIT Department of Economics)

Abstract : This paper studies the intermediation of auto loans through auto dealers using new and comprehensive data. Lenders give auto dealers discretion to price loans. The first part of our project leverages details of the contracts between lenders and dealers to demonstrate that many consumers are substantially less responsive to finance charges than to vehicle charges. This wedge in responsiveness is particularly pronounced for consumers with low income as well as consumers living in areas with low education levels. Dealers take this consumer-specific wedge into account when jointly pricing the car and the loan, leading to a form of price discrimination. We then estimate an equilibrium model that allows us to explore the implications of this wedge in an oligopolistic market. Counterfactual exercises demonstrate that the wedge in responsiveness has a substantial impact on dealer pricing behavior, consumer surplus, and the distribution of prices across areas with low and high income. Finally, we explore what happens if dealers have no discretion to price loans. Because of an effect reminiscent of double marginalization, we find that total prices would increase and consumer surplus would fall.

The Negative Consequences of Loss-framed Performance Incentives

Lamar Pierce (Washington University in St. Louis)
Alex Rees-Jones (Cornell University)
Charlotte Blank (Maritz)

Abstract : Behavioral economists have proposed that loss-averse employees increase productivity when bonuses are "loss framed"—prepaid then clawed back if targets are unmet. We theoretically document that loss framing raises incentives for costly risk mitigation and for inefficient multitasking, potentially leading to large negative performance effects. We empirically document evidence of these concerns in a nationwide field experiment among 294 car dealers. Dealers randomized into loss-framed (but financially identical) contracts sold 5% fewer vehicles than control dealers, generating a revenue loss of $45 million over 4 months. We discuss implications regarding the use of behavioral economics to motivate both employees and firms.