| This research investigates the impact of predictably irrational consumer behavior on a firm's pricing policies and profits. We rely on behavioral decision theories and consumer psychology to develop new models of consumer demand, which account for behavioral regularities, such as anchoring and loss aversion, consumer learning mechanisms and regret theory. My thesis contributes to the behavioral operations literature by embedding these new, realistic demand models into operational settings, and understanding and quantifying their eect on the firm's optimal response.;The first part of the thesis focuses on the dynamic pricing implications of consumer learning mechanisms in a repeated purchase setting. In this model, loss averse consumers are more sensitive to perceived surcharges than discounts relative to an internal reference price, determined by past price exposures. We propose two new, behaviorally motivated, asymmetric models of memory and reference price formation: (1) the peak-end rule (Fredrickson and Kahneman, 1993) and (2) loss-averse consumer learning (Gaur and Park, 2007). The latter predicts that consumers put more weight on lower than higher prices in their expectation formation, whereas the peak-end rule predicts that consumers anchor only on the most extreme and recent prices. In both cases, we characterize the optimal dynamic pricing policies of the firm by solving non-conventional dynamic programs. Overall, our results suggest that behavioral regularities, such as peak-end anchoring and loss aversion, limit the benefits of varying prices, and caution that the adverse effects of deep discounts on the firm's optimal prices and profits may be more enduring than predicted by previous consumer learning models, based on exponential smoothing.;The second part of the thesis studies the effect of anticipated regret on consumer decisions, firm profits and policies, in an advance selling context where buyers have uncertain valuations. Emotionally rational consumers act strategically in response to the firm's policies and in anticipation of regret. The effect of regret on profits critically depends on the type of regret, market structure and the firm's pricing power. We find that regret adversely affects optimal profits whenever actions (purchases) are regretted more than inactions (non-purchases). This adverse effect of regret on profits can be mitigated by offering refunds or allowing resale markets. If, on the other hand, non-purchases are regretted more than purchases, such as in limited purchase opportunities, we show that firms can benefit from regret by creating a buying frenzy in the advance period. Regret may also benefit thefirm if high-valuation consumers regret more. For capacity constrained firms, regret may lead to premium advance selling policies. |
