Essays in Optimal Pricing

Abstract

The thesis comprises four essays. The first essay provides a comprehensive survey of the implications of the theories of individual decision making most frequently used in behavioral economics for the optimal pricing strategy of the firm. The second essay focuses on habit forming behavior, namely the behavior when the valuation of the good in each period is affected by whether consumption occurred in preceding periods. It studies how consumers' habit formation affects the pricing policy of firms. Two types of consumers are considered, sophisticated and naive. The latter do not realize that their current consumption is affecting future consumption. Our main result is that under naive habit formation, the optimal pricing pattern is a three part tariff, namely a fixed fee, an amount of units for free and after their end pricing above marginal cost. The firm exploits naivety charging high price towards the end, and low in the beginning triggering the consumption of a forward looking consumer. The third essay studies a market that consists of one firm and habit forming consumers of different degrees of sophistication. The firm cannot observe the sophistication so it screens between the different types of consumers. The menu of contract offered consists of the frequently observed menu of a two-part tariff and a three-part tariff. Finally, the fourth essay proposes a second explanation of three part tariffs, based on the assumption that consumers are forward-looking but impatient. In a dynamic stochastic setting, prices that apply to large volumes tend to be paid towards the end of the contracting period and so are more heavily discounted by consumers. As a result, high prices for large volumes represent an efficient way of extracting surplus. Low prices for small volumes serve to stimulate early consumption, making it more likely that high marginal prices will apply later.