Nonlinear pricing with loss aversion
About Nonlinear pricing with loss aversion
Nonlinear pricing schedules are common in communication and subscription services and in many utilities, including water, electricity and gas, as a way to recover costs while taking into consideration consumer demand profiles.
The consumer is typically modelled as an individual which maximizes utility with a nonlinear budget constraint. However, consumers could have reference points that will affect their consumption choices.
Based on the gain/loss utility approach, we take the discrete/continuous model of consumer choice that has been widely used for demand analysis under block rates and modify it to include reference-price effects. Since empirical evidence suggests that consumers have a higher awareness of total expenses than of price, we also discuss a model of reference expense.
In particular, we show how loss aversion alters consumption decisions when the consumer treats a higher-than-reference price (or expense) as a loss. Finally, we discuss implications for utility pricing policies and services with nonlinear pricing.