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

Sanjay Jain, Haipeng Chen

Research output: Contribution to journalArticlepeer-review

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.

Original languageEnglish
Pages (from-to)2383-2400
Number of pages18
JournalManagement Science
Volume69
Issue number4
DOIs
StatePublished - Apr 2023

Bibliographical note

Publisher Copyright:
Copyright: © 2022 INFORMS.

Keywords

  • behavioral economics
  • game theory
  • pricing
  • sunk cost bias
  • time-inconsistent preferences

ASJC Scopus subject areas

  • Strategy and Management
  • Management Science and Operations Research

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