Screening Loss Averse Consumers

We study optimal pricing strategy of a monopolist who faces consumers that have heterogeneous private tastes, have reference-dependent preferences, and are subject to loss aversion. There is asymmetric of information and monopolist does not observe the consumers’ valuations. Assuming that the monopolist can make consumers expect to buy the desired variety of the good, and that these expectations determine the consumers’ reference points, we obtain two main results. First, with expectation-based loss aversion, menu pricing is possible even if the single-crossing property is violated (high-valuation consumers do not have a larger marginal utility of quality than low-valuation consumers). Second, when firms face consumers with expectation-based loss aversion, menu pricing may become more desirable to the monopolist compared to selling only to high-valuation consumers.