Pricing Misperceptions: Explaining Pricing Structure in the Cell Phone Service Market

Abstract

The cell phone service market is an economically significant market that has substantially increased consumer welfare. In this article, we focus on the pricing of cell phone service. The common pricing structure is a three‐part tariff comprising: (1) a monthly charge; (2) a fixed number of minutes that the monthly charge pays for; and (3) a per‐minute price for minutes beyond the plan limit. Using a unique data set of consumer‐level monthly billing and usage information for 3,730 consumers at a single wireless provider, we evaluate the explanatory power of three accounts of the three‐part tariff: a rational choice account; a behavioral account proposed by Grubb (2009) that supposes that consumers are overconfident in their estimates of their future usage; and a second behavioral account that posits that some consumers overestimate their average future usage while others underestimate it. We quantify the mistakes that consumers make in plan choice and, extrapolating from our data, estimate that these mistakes cost U.S. consumers over $13 billion annually. Our analysis suggests that regulation mandating the disclosure of product use information can be socially desirable in the cell phone service market.