Understanding Markets with Socially Responsible ConsumersAbstract:
Many consumers care about climate change and other externalities associated with their purchases. We analyze the market behavior of such "socially responsible consumers," derive properties of the resulting competitive equilibria, and assess the effectiveness of different policies. In violation of price taking, a vanishingly small consumer cares about her impact on the market equilibrium to a non-vanishing extent. Specifically, other participants dampen the consumer's direct effect on the externality, undermining responsible behavior. Dampening implies that even if all consumers value the externality akin to the social planner, they mitigate too little in any equilibrium, and may coordinate on the worst of multiple equilibria. To motivate consumers to lower the externality in a closed economy, a unit tax is superior to a cap-and-trade system, but there are policies that are better than a tax. Furthermore, under trade with a large or very polluting partner, a cap is better than a tax. When there are two products that are perfect substitutes in consumption but generate different externalities, there is always a "selfish equilibrium," in which the products have the same price and consumers are indifferent between them. Under conditions we identify, the selfish equilibrium is the unique equilibrium. In a selfish equilibrium, a cap and a unit tax on the dirty product achieve the same outcomes. In non-selfish equilibria, a proportional subsidy on the clean product dominates both a unit tax and a cap.
Joint with Marc Kaufmann. Updated June 2023.
We model an agent who stubbornly underestimates how much his behavior is driven by undesirable motives, and, attributing his behavior to other considerations, updates his views about those considerations. We study general properties of the model, and then apply the framework to identify novel implications of partially naive present bias. In many stable situations, the agent appears realistic in that he eventually predicts his behavior well. His unrealistic self-view does, however, manifest itself in several other ways. First, in basic settings he always comes to act in a more present-biased manner than a sophisticated agent. Second, he systematically mispredicts how he will react when circumstances change, such as when incentives for forward-looking behavior increase or he is placed in a new, ex-ante identical environment. Third, even for physically non-addictive products, he follows empirically realistic addiction-like consumption dynamics that he does not anticipate. Fourth, he holds beliefs that — when compared to those of other agents — display puzzling correlations between logically unrelated issues. Our model implies that existing empirical tests of sophistication in intertemporal choice can reach incorrect conclusions. Indeed, we argue that some previous findings are more consistent with our model than with a model of correctly specified learning.
Joint with Paul Heidhues and Philipp Strack. Updated January 2023.
We develop models of markets with procrastinating consumers where competition operates — or is supposed to operate — both through the initial selection of providers and through the possibility of switching providers. As in other work, consumers fail to switch to better options after signing up with a firm, so at that stage they exert little downward pressure on the prices they pay. Unlike in other work, however, consumers are not keen on starting with the best available offer, so price competition fails at this stage as well. In fact, a competition paradox results: an increase in the number of firms or the intensity of marketing increases the frequency with which a consumer receives switching offers, so it facilitates procrastination and thereby potentially raises prices. By implication, continuous changes in marketing costs can, through a self-reinforcing process, lead to discontinuous changes in market outcomes. Sign-up deals do not serve their classically hypothesized role of returning ex-post profits to consumers, and in some cases even exacerbate the failure of price competition. Consumer procrastination thus emerges as a novel source of competition failure that applies in situations where other theories of competition failure do not.
Joint with Paul Heidhues and Takeshi Murooka. Updated May 2023.
Overconfidence and PrejudiceAbstract:
We develop a model in which an overconfident agent learns about groups in society from observations of his and others' successes. In our model, both the agent's information and his beliefs are multi-dimensional, allowing us to study interactions between different views. Overall, society always exhibits an in-group bias — the average person sees his group relative to other groups too positively — but this general tendency toward prejudice exhibits systematic comparative-statics patterns. First, a person is most likely to have negative opinions about other groups he competes with. Second, while information about another group's achievements does not lower a person's prejudice, information about economic or social forces affecting the group can, and personal contact with group members has a beneficial effect that is larger than in classical settings. Third, the agent's beliefs are subject to "bias substitution," whereby forces that decrease his bias regarding one group tend to increase his biases regarding unrelated other groups. Methodologically, to make our analysis of interdependent multi-dimensional beliefs possible, we develop tools for studying learning under high-dimensional misspecified models.
Joint with Paul Heidhues and Philipp Strack. Updated January 2023.
Financial Choice and Financial InformationAbstract:
We analyze the implications of increases in the selection of, and information about, derivative financial products in a model in which investors neglect informational differences between themselves and issuers. We assume that investors receive information that is noisy and inferior to issuers' information, and that issuers can select the set of underlying assets when designing a security. In contrast to the received wisdom that diversification is helpful, we show that when custom-designed diversification across a large number of underlying assets is possible, then expected utility approaches negative infinity. Even beyond this limiting case, any expansion in choice induced by either an increase in the maximum number of assets underlying a security, or an increase in the number of assets from which the underlying can be selected, Pareto-lowers welfare. Furthermore, under reasonable conditions an improvement in investor information Pareto-lowers welfare by giving investors the false impression that they can spot good deals. An increase in competition between issuers does not increase welfare, and even increases investors' incentive to acquire welfare-reducing information. Restricting the set of underlying assets the issuer can use -- a kind of standardization -- raises welfare, and once this policy is adopted, increasing investor information becomes beneficial.
Joint with Péter Kondor. Updated May 2017.