How heuristic pricing shapes the aggregate market: the “Cheap Twin Paradox”

How do firms set prices when faced with an uncertain market? We study the pricing strategies of car dealers for used cars using online data and interviews. We find that 97% of 628 dealers employ an aspiration-level heuristic similar to a Dutch auction. Dealers adapt the parameters of the heuristic—initial price, duration, and change in price—to their local market conditions, such as number of competitors, population density, and GDP per capita. At the same time, the aggregate market is described by a model of equilibrium price dispersion. Unlike the equilibrium model, the heuristic correctly predicts systematic pricing characteristics such as high initial price, price stickiness, and the “cheap twin paradox.” We also find first evidence that heuristic pricing can generate higher profits given uncertainty than the equilibrium strategy.