Jeffrey Ely

Jeff Ely is the Charles E. and Emma H. Morrison Professor of Economics at Northwestern University and an accomplished latte-artist. He is co-director of the Center for Economic Theory, a member of several editorial boards and co-author of the blog Cheap Talk.

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1

Jan

Optimal Contracts for Loss-Averse Consumers

We study optimal contract design between a monopolist and a continuum of potential buyers under asymmetric information and reference-dependent preferences. In our model, the consumer’s total valuation for product quality is composed of the intrinsic consumption valuation, which is affected by privately known types, and an additional gain-loss valuation that depends on deviations of purchased quality from the reference quality level. Buyers are loss-averse, so that deviations from the reference point are evaluated differently depending on whether they are gains or losses. As K ̋oszegi and Rabin (2006), we let gains and losses relative to the reference point be evaluated in terms of changes in the consumption valuation, but we differ in terms of how comparisons take place. In particular, each consumer evaluates actual consumption relative to his own, type-dependent reference quality level alone. We consider different ways in which reference quality levels are formed, capturing this process by a reference plan as a monotone function of consumer types. We derive optimal menu of contracts for loss- averse consumers and show that, depending on how reference points are formed, there is substantial difference between optimal contracts for loss-averse consumers and optimal contracts in the absence of loss aversion, and there are novel effects for product line design due to the interaction of loss aversion and incomplete information. Download


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Jeffrey Ely

Jeff Ely is the Charles E. and Emma H. Morrison Professor of Economics at Northwestern University and an accomplished latte-artist. He is co-director of the Center for Economic Theory, a member of several editorial boards and co-author of the blog Cheap Talk.

Click here to blast this page, Asteroids style. Space bar fires, arrows move.

1

Jan 2015

Optimal Contracts for Loss-Averse Consumers

We study optimal contract design between a monopolist and a continuum of potential buyers under asymmetric information and reference-dependent preferences. In our model, the consumer’s total valuation for product quality is composed of the intrinsic consumption valuation, which is affected by privately known types, and an additional gain-loss valuation that depends on deviations of purchased quality from the reference quality level. Buyers are loss-averse, so that deviations from the reference point are evaluated differently depending on whether they are gains or losses. As K ̋oszegi and Rabin (2006), we let gains and losses relative to the reference point be evaluated in terms of changes in the consumption valuation, but we differ in terms of how comparisons take place. In particular, each consumer evaluates actual consumption relative to his own, type-dependent reference quality level alone. We consider different ways in which reference quality levels are formed, capturing this process by a reference plan as a monotone function of consumer types. We derive optimal menu of contracts for loss- averse consumers and show that, depending on how reference points are formed, there is substantial difference between optimal contracts for loss-averse consumers and optimal contracts in the absence of loss aversion, and there are novel effects for product line design due to the interaction of loss aversion and incomplete information. Download


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Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <strike> <strong>