Title: Behavioral Pricing: Consumer Biases and Firm Response

Abstract:  We the effect of cognitive consumer biases, such as framing, loss aversion, 
regret and peak-end anchoring, on dynamic pricing policies. Our stylised models capture 
realistic consumer behavior, motivated by empirical evidence and behavioral theories 
(e.g prospect theory, mental accounting, adaptation). We investigate how firms should 
structure optimal pricing policies in response to consumer biases. We characterize the 
sensitivity of  optimal pricing policies to behavioral parameters, and compare these 
policies to non-behavioral benchmarks. Two distinct frameworks are considered, where 
consumers purchase decisions are (1) retrospective (relative to past prices), respectively 
(2) anticipative (relative to future prices). (1) In a repeated interaction setting,  
myopic consumers anchor on past prices (summarized by reference prices) to make purchase 
decisions. We find that perception asymmetries in decision and experience utility, as 
captured by loss aversion and peak-end anchoring, lead to a range of constant optimal 
prices. Behavioral regularities insure that prices converge to a steady state, and either 
prices or price perceptions are monotonic. Firms that ignore these effects systematically 
under-price. (2) In an advance purchase setting, strategic consumers with uncertain valuation 
anticipate regret in wait-or-buy decisions. We characterize the effect of regret on customer 
decisions and surplus, as well as firm profits and pricing policies. We explain under what 
market conditions regret is relevant for the firm. Regret reduces advance selling opportunities 
and leads to lower profits for a strategic firm.