Monday, September 30, 2013

Some links on consumer exploitation

Philip posted recently on the potential for behavioural techniques to be used to exploit consumers. It is clear that the techniques being develop to help people make better decisions could just as easily be used to encourage them to make less active decisions for the purpose of capturing rents. Furthermore, there is a literature developing on how sub-optimal aspects of consumer decision-making might be exploited by firms. Below is a list of links to relevant papers that I will update over the course of the term. Suggestions welcome.

Mark Armstrong and John Vickers "Consumer protection and contingent charges". A later version of this is available in the Journal of Economic Literature.
Contingent charges for fin…nancial services, such as fees for unauthorized overdrafts, are often controversial. We study the economics of contingent charges in a stylized setting with naive and sophisticated consumers. We contrast situations where the naive benefi…t from the presence of sophisticated consumers with situations where competition works to subsidize the sophisticated at the expense of the naive, arguably unfairly. The case for regulatory intervention in these situations depends in good part, but not only, on the weight placed on distributional concerns. The economic and legal issues at stake are well illustrated by a case on bank charges recently decided by the UK Supreme Court.
Heidhues and Koszegi on Exploitative Innovation. Abstract below. Several other of Koszegi's papers useful on this theme. 

We analyze innovation incentives in a simple model of a competitive retail market with naive consumers. Firms selling perfect substitutes play a game consisting of an innovation stage and a pricing stage. At the pricing stage, firms simultaneously set a transparent \up-front price" and an \additional price," and decide whether to shroud the additional price from naive consumers. To capture especially financial products such as banking services, credit cards, and mutual funds, we allow for a  floor on the product's up-front price. At the preceding innovation stage, a rmcan invest either in increasing the product's value (value-increasing innovation) or in increasing the maximum additional price (exploitative innovation). We show that if the price floor is not binding, the incentive for either kind of innovation equal the \appropriable part" of the innovation, implying similar incentives for exploitative and value-increasing innovations. If the price floor is binding, however, innovation incentives are often stronger for exploitative than for value-increasing innovations. Because learning ways to charge higher additional prices increases the profi ts from shrouding and thereby lowers the motive to unshroud, a rm may have strong incentives to make appropriable exploitative innovations, and even stronger incentives to make non-appropriable exploitative innovations. In contrast, the incentive to make non-appropriable value-increasing innovations is zero or negative, and even the incentive to make appropriable value-increasing innovations is strong only if the product is socially wasteful. These results help explain why firms in the nancial industry have been willing to make innovations others could easily copy, and why these innovations often seem to have included exploitative features.

The Office of Fair Trading investigation into fees for fitness clubs an interesting example of where a regulator specifically took action on a practice said to be exploiting consumer biases. 

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