UCL School of Management is delighted to welcome Joonhwi Joo, Chicago, to host a research seminar discussing ‘Buying a larger package with quantity surcharge: Information friction or preference heterogeneity?’

Abstract

Sales of larger packages with quantity surcharges occur often in the consumer packaged goods industry. This phenomenon poses a challenge to rationalizing consumer behaviors because the same amount of an identical product can be bought at a cheaper price. I present evidence that consumers lose a considerable amount of money by purchasing quantity surcharged larger packages. I develop and estimate a structural econometric model that combines (i) rationally inattentive consumers with (ii) the address model of consumer demand in the product characteristics space. By simulating consumer demand using model parameter estimates, I decompose the contribution of information friction and preference heterogeneity over package sizes on sales of larger packages with quantity surcharges. The estimated model predicts that only 40% of sales of larger packages with quantity surcharges can be attributed to information friction. I suggest revenue-improving, nonlinear pricing schemes that preserve consumer welfare at the current level. Under the pricing schemes, retailers can raise their revenues by up to 18%, and the corresponding sales of larger packages with quantity surcharge triples. As a methodological contribution, I state and prove the theorem that allows estimating the Rational Inattention (RI) model as if estimating an augmented logit model.