Pricing and Inventory Management When Consumers' Emotions Run High

We study a setting in which consumers can either purchase a product for which they have uncertain valuation and, hence, uncertain utility or choose an outside option for which their utility is certain. The uncertainty in the product valuation is resolved after a consumer chooses either of the two options. If the consumer chooses to purchase the product and compares her realized utility from the product with her expectation of it, she experiences disappointment or elation. If, however, she compares her (realized) utilities from the chosen and the foregone options, she experiences regret or rejoice. These emotions further affect the consumer’s total utility. Thus, the consumer’s ex-ante anticipation of such emotions may impact her purchase decision. We develop a novel demand model that accounts for this impact and derive demand functions for a product with uncertain valuation. We show that when consumers anticipate disappointment-elation, their disappointment aversion decreases product demand. Furthermore, when consumers anticipate only regret-rejoice, this anticipation has no impact on product demand. However, when consumers anticipate both disappointment-elation and regret-rejoice, then the anticipated regret-rejoice alleviates the negative impact of consumers' disappointment aversion on product demand. We also show that the impact of these anticipated emotions on product demand can be distilled into a single demand parameter which is independent of the product price. Consequently, our demand functions have convenient properties which facilitate the study of canonical operations management models without loss of tractability. Specifically, when the firm makes joint pricing and quantity decisions, the optimal price and quantity decrease as consumers’ disappointment aversion increases and the firm’s profit loss can be arbitrarily large if it does not account for consumers’ disappointment aversion. Our numerical experiments demonstrate that the nature of consumers’ uncertainty significantly impacts the firm's optimal decisions and profit. For example, an increase in the uncertainty in consumers' valuation of the product negatively impacts the firm's profit. In contrast, an increase in the complexity of available information about product characteristics positively impacts the firm's profit. The sizes of both these impacts increase as consumers’ disappointment aversion increases