Lower Price Limits for Flat-Fee Service Contracts Under Risk

Abstract

We analyze price limits as decision aids for identifying favorable and unfavorable contracts from the perspective of a selling firm. The corresponding decision problem is shaped by uncertainty of the outcomes and incomplete information about the decision maker's preferences. The proposed price limits are based on the theory of almost stochastic dominance. We make this theory more applicable by contributing a version of almost second-degree stochastic dominance that (1) refers to the same aggregate information about marginal utilities as almost first-degree stochastic dominance, (2) does without information about higher order derivatives of the utility function, and (3) is implied by almost first-degree stochastic dominance (hierarchy property). Numerical examples show that the incomplete preference information may lead to substantial improvements of the price limits relative to the situation where no preference information is available.