Optimal Nonlinear Pricing by a Regret-Averse Monopoly

Abstract

This paper examines the optimal nonlinear pricing by a regret-averse monopolist who sells a single good to two types of buyers with high and low valuation. The monopolist's preferences are characterized by a modified utility function that includes disutility from having chosen ex-post suboptimal alternatives. The magnitude of regret is measured by the difference between the actual profit and the maximum profit that could have been earned should the monopolist have observed each buyer's true taste parameter. We show that regret aversion affects the rent extraction-efficiency tradeoff under asymmetric information. When buyers are more likely to have high (low) valuation, the regret-averse monopolist reduces (enlarges) the downward distortion on the second-best quantity offered to low valuation buyers, thereby resulting in lower (higher) unit prices paid by all buyers and making high valuation buyers better (worse) off. The regret-averse monopolist always earns a lower expected profit.