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Deception and Consumer Protection in Competitive MarketsAbstract:

This paper discusses some of our recent work on competitive markets in which consumers systematically misunderstand either their own behavior, or contract or product features. We briefly discuss evidence that consumers indeed systematically mispredict their own future behavior as well as the abundance of evidence that consumers misunderstand certain contract or product features. Based on Heidhues and Kőszegi (2010), we then introduce a competitive credit-market model with time-inconsistent and partially naive borrowers, and discuss some implications for possible consumer-protection regulation such as the US Credit CARD Act 2009 and the 2008 amendments by the Federal Reserve Board to the Truth in Lending Act. In that model as well as in existing work on consumer misunderstanding of contract terms in competitive environments, firms make ex-post profits from naive consumers but need to hand these profits back ex ante to attract consumers. To highlight that in some important markets ex-ante competition is unlikely to compensate for ex-post exploitation, we introduce a simple competitive-market model with consumer misunderstandings in which the incentive of firms to hand these profits out ex ante is limited by the presence of arbitrageurs who are not interested in the product itself but who exploit contracts that hand out money ex ante. We identify conditions under which such arbitrageurs effectively create a price floor, inducing firms to earn positive profits in seemingly competitive industries. These conditions are likely met in many consumer finance markets, and we propose that the resulting constraint on ex-ante competition is important for understanding the functioning and regulation of these retail-finance markets.

Joint with Paul Heidhues and Takeshi Murooka. In the Anthology on Pros and Cons of Consumer Protection, 2011.

Revealed Mistakes and Revealed Preferences

Joint with Matthew Rabin. In The Foundations of Positive and Normative Economics, Andrew Caplin and Andrew Schotter (editors), Oxford University Press (2008), Chapter 8, pp. 193-209.

Mistakes in Choice-Based Welfare Analysis

Joint with Matthew Rabin. American Economic Review (2007), 97(2), pp. 477-481.

On the Feasibility of Market Solutions to Self-Control ProblemsAbstract:

I consider behavior and welfare in competitive markets supplying harmful or beneficial goods when consumers at each moment in time prefer immediate gratification more than they would themselves approve. In a spot market and without commitment to her consumption level in advance, a decisionmaker overconsumes harmful goods and underconsumes beneficial goods from her own point of view. The optimal level of consumption can be achieved by adjusting prices in a way that forces a consumer to fully internalize the future consequences of consumption. Calibrations in the case of tobacco and exercise indicate that the optimal interventions can be very large. I examine the extent to which market forces can provide such “self-control” interventions when firms and consumers can agree on price schedules ex ante. If consumers are bound to the firm whose offer they accept and price schedules are restricted to two-part tariffs, consumption is much closer to optimal than in a spot market. But if consumers cannot be prevented from purchasing from other firms ex post, the consumption of harmful goods is as if only a spot market was available. And if firms can engage in non-linear pricing, perfectly sophisticated consumers consume optimally in equilibrium, but individuals with an arbitrarily small amount of overoptimism regarding their self-control problem consume as if they were buying on the spot market. Hence, government intervention may typically be necessary to correct self-control problems.

Swedish Economic Policy Review (2005), 12(2), pp. 71-94.