DP16946 Loss Leading with Salient Thinkers

Author(s):	Roman Inderst, Martin Obradovits
Publication Date:	January 2022
Keyword(s):	Competition law, imposition of price floors, Loss leading, price competition, price promotion, salient-thinking consumers
JEL(s):	D11, D22, L11, L15
Programme Areas:	Industrial Organization
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=16946

In various countries, competition laws restrict retailers' freedom to sell their products below cost. A common rationale, shared by policymakers, consumer interest groups and brand manufacturers alike, is that such "loss leading" of products would ultimately lead to a race-to-the-bottom in product quality. Building on Varian's(1980) model of sales, we provide a foundation for this critique, though only when consumers are salient thinkers, putting too much weight on certain product attributes. But we also show how a prohibition of loss leading can backfire, as it may make it even less attractive for retailers to stock high-quality products, decreasing both aggregate welfare and consumer surplus.