Sunk Cost Bias and Time Inconsistency: A Strategic Analysis of Pricing Decisions

Sanjay Jain () and Haipeng (Allan) Chen ()
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Sanjay Jain: Naveen Jindal School of Management, University of Texas at Dallas, Richardson, Texas 75080
Haipeng (Allan) Chen: Gatton College of Business and Economics, University of Kentucky, Lexington, Kentucky 40506

Management Science, 2023, vol. 69, issue 4, 2383-2400

Abstract: It is generally acknowledged that sunk cost bias leads to suboptimal decisions, such as escalation of commitment. Some researchers, however, suggest that sunk cost bias can be beneficial when consumers have self-control problems. In this paper we explore the case when consumers with sunk cost bias have time-inconsistent preferences and, therefore, suffer from self-control problems. We experimentally demonstrate that sunk costs can make subjects better off by inducing higher effort. We then develop an analytical model to explore the implications of sunk cost bias for firm’s pricing strategy. We find that, in the presence of sunk cost bias, higher prices can lead to higher experienced quality. We show that sunk cost bias can sometimes improve firm’s profits, lead to lower prices, and increase welfare. Our results suggest that, when consumers use a product for multiple periods, pricing policies such as 0% financing, which are often viewed as exploitative, can instead lead to lower total prices, higher profits, and higher welfare.

Keywords: sunk cost bias; time-inconsistent preferences; behavioral economics; game theory; pricing (search for similar items in EconPapers)
Date: 2023
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:69:y:2023:i:4:p:2383-2400

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