The Bright Side of Inequity Aversion

Abstract

Modern consumers are concerned about not only their material payoff, but also the fairness of the transaction when making purchasing decisions. In this paper, we investigate how consumers’ inequity aversion affects a manufacturer who sources inputs from upstream suppliers. We find that, when the manufacturer sources from a single supplier or when consumers observe the manufacturer’s cost, inequity aversion hurts both the supplier’s and manufacturer’s profits. However, when the manufacturer sources from multiple suppliers and consumers do not observe the manufacturer’s cost, inequity aversion reduces both the suppliers’ and manufacturer’s margins, which significantly alleviates the double marginalization problem, increases consumer demand, and improves channel efficiency. As a result, inequity aversion benefits the suppliers, manufacturer, and consumers alike, leading to a “win–win–win” outcome. By comparing cases in which consumers observe and do not observe the manufacturer’s cost, we also find that, when faced with inequity-averse consumers, a manufacturer may find it optimal to withhold its cost information to help secure lower procurement costs from upstream suppliers.