Loss-Leader Pricing and Upgrades

A new theory of loss-leader pricing is provided in which firms offer low advertised prices for certain goods to signal that their other unadvertised (substitute) goods are not priced too high. The theory applies to the pricing of upgrades, in which the basic version of the good is advertised, with a particularly low price, so as to signal that the price of the upgraded version, which is not advertised, is not too high. The results contrast with most existing loss-leader theories in that firms make a loss on some consumers (who buy the basic version of the good) and a profit on others (who buy the upgrade). The theory provides an application of the framework of In and Wright (2012) in which private choices (rather than exogenous types) are signaled