Abstract

We study the implications for monopoly pricing strategies and product diversity of consumers’ temptation when the differentiation of the product is horizontal. Consumers have an ex-ante ideal product, but they and the monopolist are aware that consumers may fall prey to “temptation preferences” ex-post with some probability. Our results indicate that when consumers are aware of their dynamic change in preferences, the firm cannot take advantage of consumers’ temptation but instead, in order to attract them into the store, the firm must compensate ex-ante consumers for the possibility of yielding to temptation once inside the store. As a result, this paper shows that the firm narrows the variety of products, not offering those products close to temptation preferences. Moreover, it is shown that product prices and firm’s profits decrease with the probability of temptation and with the consumers’ awareness of their dynamic inconsistency.