Preventing commercial piracy when consumers are loss averse

Abstract

© 2020. This document is made available under the CC-BY-NC-ND 4.0 license http://creativecommons.org/licenses/by-nc-nd/4.0/ This document is the submitted version of a published work that appeared in final form in Information Economics and PolicyI analyze how the loss aversion of consumers affects the strategies of the government and the incumbent for preventing commercial piracy. To that end, I develop a sequential duopoly model of vertical product differentiation with price competition in which con- sumers have a reference-dependent utility. Regardless of the quality of the illegal copy, conventional models that do not take into account the loss aversion of consumers overes- timate the government’s effort to deter piracy but underestimate the incumbent’s effort. Contrary to conventional wisdom, I find that blocking the entry of a pirate by the govern- ment can provide more welfare than accommodating it. However, the government will not block it because socially it is better to encourage the incumbent to establish a price low enough to deter the pirate from entering