PRODUCT UPGRADE AND PRICING IN THE PRESENCE OF TIME-INCONSISTENT CONSUMERS

Abstract

How do time-inconsistent consumers make purchase choices between two successive products? Utilizing semi-hyperbolic utility function, we model consumers’ inconsistent upgrade behavior due to present-biased preferences. Specifically, naive consumers who cannot accurately predict their present-biased preference will make inconsistent intertemporal choices, but sophisticated consumers are consistent owing to their ability to predict such bias. Based on comprehensive demand patterns, we further model and solve a monopolist’s decision problem about price and quality. First, the firm can adopt either an expensive upgrade (EU) strategy or a less-expensive upgrade (LU) strategy, corresponding to either a high or a low net value for the upgrade. With an EU strategy, the firm can induce more naive consumers with moderate valuations not just to purchase the 1st-generation product (G1) but also to upgrade to the 2nd-generation product (G2). Second, our analysis sheds light on the importance of a resale market. A positive resale price – together with the present-biased preferences – drives naive consumers to purchase a G1 and also inconsistently upgrade to a G2. Last, our numerical analysis demonstrates an interesting finding wherein a more severe time-inconsistent preference could decrease the monopolist’s profit.