Pricing Misperceptions: Explaining Pricing Structure in the Cell Phone Service Market

Authors


  • We are grateful to the editors and to three anonymous referees for their helpful comments and suggestions. We also thank Jennifer Arlen, Adi Ayal, Jonathan Baker, Lucian Bebchuk, Ryan Bubb, Kevin Davis, Clay Gillette, Michael Grubb, Raghuram Iyengar, Lewis Kornhauser, Florenica Marotta Wurgler, Nicola Persico, Rick Pildes, Martin Raphan, Howard Shelanski, Phil Weiser, and workshop participants at NYU for their comments and suggestions. We gratefully acknowledge the financial support of the D’Agostino/Greenberg Fund at NYU School of Law. We thank the Center for Customer Relationship Management at Duke University for letting us use their Telecom Dataset. Michael Biondi, Joseph Eno, Osnat Dafna, and Paul McLaughlin provided outstanding research assistance.

Oren Bar-Gill, Professor of Law and Co-Director of the Center for Law, Economics and Organization, New York University School of Law, 40 Washington Sq. S. #411, New York, NY 10012; email: bargill@nyu.edu. Stone is a Furman Fellow at New York University School of Law.

Abstract

The cell phone service market is an economically significant market that has substantially increased consumer welfare. In this article, we focus on the pricing of cell phone service. The common pricing structure is a three-part tariff comprising: (1) a monthly charge; (2) a fixed number of minutes that the monthly charge pays for; and (3) a per-minute price for minutes beyond the plan limit. Using a unique data set of consumer-level monthly billing and usage information for 3,730 consumers at a single wireless provider, we evaluate the explanatory power of three accounts of the three-part tariff: a rational choice account; a behavioral account proposed by Grubb (2009) that supposes that consumers are overconfident in their estimates of their future usage; and a second behavioral account that posits that some consumers overestimate their average future usage while others underestimate it. We quantify the mistakes that consumers make in plan choice and, extrapolating from our data, estimate that these mistakes cost U.S. consumers over $13 billion annually. Our analysis suggests that regulation mandating the disclosure of product use information can be socially desirable in the cell phone service market.

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