Consumer loss aversion, product experimentation and tacit collusion

Two firms compete to attract loss averse consumers that are uncertain about how well the goods on sale fit their needs. To resolve valuation uncertainty, firms can allow prospective customers to test (experiment) their products before purchase. We investigate firms’ dynamic incentives to allow experimentation and analyze the resulting effects on the profitability and the stability of tacit collusion. Depending on the regulatory regime in place – i.e., whether experimentation is forbidden, mandated or simply allowed but not imposed (laissez-faire) – the degree of loss aversion has ambiguous effects both on the profits that firms can achieve through tacit collusion and on the stability of these agreements. While in static environments consumer welfare is always maximized by a policy that forbids experimentation, the opposite happens in a dynamic environment.