More than a Penny's Worth : Left-Digit Bias and Firm Pricing

Firms arguably price at 99-ending prices because of left-digit bias, the tendency of consumersto perceive a $4.99 as much lower than $5.00. Using retail scanner data on thousands of productsand dozens of retailers, I provide reduced-form support for this explanation. I then structurallyestimate the magnitude of left-digit bias, and find that consumers respond to a 1-cent increasefrom a 99-ending price as if it were a 15-25 cent increase. Next, I analyze how firms shouldrespond to left-digit biased demand. I solve and estimate a model that makes three key predictions:(1) prices should bunch at 99-ending prices; (2) there should be ranges of missing priceswith low price-endings; (3) these ranges of missing prices should increase with the dollar digit.Qualitatively, these predictions hold. Firms respond to the bias with high shares of 99s andmissing low-ending prices. Quantitatively, however, firms price as if the bias were much smallerand demand were more elastic, so they use dominated prices. I estimate that the retailer isforgoing 1-3 percents of potential gross profits due to this misperception