DP2562 Choosing the Wrong Calling Plan? Ignorance, Learning, and Risk Aversion

Author(s): Eugenio J Miravete
Publication Date: September 2000
Keyword(s): Expectation Bias, Learning, Risk Aversion, Service Switching, Tariff Choice
JEL(s): D42, D82, L96
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2562

It is commonly believed that consumers behave irrationally when subscribing optional telephone tariffs. The fact that they show a strong preference for flat rate options has commonly been interpreted as evidence of irrational behavior since such a choice is believed not to be cost-minimizing ex post in most cases. My results, obtained using the data from the 1986 Kentucky tariff experiment, contradict these views and provide strong evidence in favour of the rationality of consumers' choices. I found that expectations on future consumption play a major role in the choice of tariffs but also that consumption forecast errors are more related to the volume of local telephone usage than to any particular demographic profile. More importantly, the evidence shows that there exist important learning effects that induce tariff switching in order to minimize the magnitude of monthly bills even in the short term and responding to very small cost differences. Finally, risk aversion is ruled out as a possible source of consumers' biased taste for flat tariffs.