Selling substitute goods to loss‐averse consumers: limited availability, bargains, and rip‐offs

Abstract

Why are some sale items subject to limited availability while other substitute items are available in large quantities and are priced relatively high at the same point in time? Can such a retail strategy lure consumers into purchasing the more expensive item? This paper characterizes the pro…t-maximizing pricing and product-availability strategies for a retailer selling two substitute goods to loss-averse consumers and shows that limited-availability sales can manipulate consumers into an ex-ante unfavorable purchase. Consumers have unit demand, are interested in buying only one good, and their reference point is given by their recent rational expectations about what consumption value they would receive and what price they would pay. The seller maximizes pro…ts by raising the consumers'reference point through a tempting discount on a good available only in limited supply (the bargain) and cashing in with a high price on the other good (the rip-o¤), which the consumers buy if the bargain is not available to minimize their disappointment. The seller might prefer to o¤er a deal on the more valuable product, using it as a bait, because consumers feel a larger loss, in terms of forgone consumption, if this item is not available. I also show that the bargain item can be a loss leader, that the seller's product line is not welfare-maximizing and that she might supply a socially wasteful product. The model suggests that the current FTC Guides Against Bait Advertising, by allowing retailers to employ limited-availability sales, could reduce consumer and social welfare.JEL classi…cation: D11; D42; L11.

Unplanned Purchases and Retail Competition

“…Other models, also without consumer bias, such as Ambrus and Weinstein (2008), argue that loss leading is unlikely to arise, which is similar to what Beard and Stern (2008) argue when consumers are homogeneous. Rosato (2016) shows how bait and switch may be optimal when consumer preferences exhibit loss aversion.…”

Advertising and attachment: exploiting loss aversion through prepurchase information

“…This article contributes to a recent literature that analyzes the implications of expectationbased loss aversion for trade between consumers and firms. The two closest articles to ours are Heidhues and Kőszegi (2014) and Rosato (2016). They also study how a monopolist can exploit consumers' loss aversion through marketing strategies.…”

Loss leading with salient thinkers

“…Several related articles have incorporated different behavioral biases to explain the occurrence of loss leading and low‐price strategies, such as loss aversion in Rosato (2016). There, the loss leader works as a “bait” that lures consumers into the store and shapes their reference point.…”