Bounded Rationality and Industrial Organization

ISBN : 9780199334261

Ran Spiegler
240 ページ
161 x 236 mm

Conventional economic theory assumes that consumers are fully rational, that they have well-defined preferences and easily understand the market environment. Yet, in fact, consumers may have inconsistent, context-dependent preferences or simply not enough brain-power to evaluate and compare complicated products. Thus the standard model of consumer behavior-which depends on an ideal market in which consumers are boundlessly rational-is called into question. While behavioral economists have for some time confirmed and characterized these inconsistencies, the logical next step is to examine the implications they have in markets. Grounded in key observations in consumer psychology, Bounded Rationality and Industrial Organization develops non-standard models of "boundedly rational" consumer behavior and embeds them into familiar models of markets. It then rigorously analyses each model in the tradition of microeconomic theory, leading to a richer, more realistic picture of consumer behavior. Ran Spiegler analyses phenomena such as exploitative price plans in the credit market, complexity of financial products and other obfuscation practices, consumer antagonism to unexpected price increases, and the role of default options in consumer decision making. Spiegler unifies the relevant literature into three main strands: limited ability to anticipate and control future choices, limited ability to understand complex market environments, and sensitivity to reference points. Although the challenge of enriching the psychology of decision makers in economic models has been at the frontier of theoretical research in the last decade, there has been no graduate-level, theory-oriented textbook to cover developments in the last 10-15 years. Thus, Bounded Rationality and Industrial Organization offers a welcome and crucial new understanding of market behavior-it challenges conventional wisdom in ways that are interesting and economically significant, and which in the end effect the well-being of all market participants.


1 Introduction
1.1 Bibliographic Notes
I Anticipating Future Preferences
2 Dynamically Inconsistent Preferences I: Unconstrained Contracting
2.1 The Multi-Selves Model
2.1.1 Naivety
2.2 Monopoly Pricing
2.2.1 Optimal Price Schemes for Sophisticated Consumers
2.2.2 Optimal Price Schemes for Naive Consumers
2.2.3 Screening the Consumer's Type
2.3 Competitive Pricing
2.4 Welfare Analysis
2.5 Educating Naive Consumers
2.6 The Interpretation of Naivety
2.7 Two Applications
2.8 Other Topics
2.8.1 The (?, ?) Model
2.8.2 Preference Heterogeneity
2.9 Summary
2.10 Bibliographic Notes
3 Dynamically Inconsistent Preferences II: Constrained Contracting
3.1 Two-Part Tariffs
3.1.1 Departure from Marginal-Cost Pricing
3.1.2 Welfare Analysis
3.2 Destabilization of Commitment Devices: Renegotiation and Spot Market
3.3 Self-Control
3.3.1 Implications for Monopoly Pricing
3.3.2 Do Self-Control Costs Hamper Competition?
3.4 Summary
3.5 Bibliographic Notes
4 Dynamically Inconsistent Preferences III: Partial Naivety
4.1 Magnitude Naivety
4.1.1 Monopoly Pricing
4.1.2 Are More Sophisticated Consumers Always Better Off?
4.2 Frequency Naivety
4.2.1 First-Best Monopoly Pricing
4.2.2 Second-Best Monopoly Pricing
4.2.3 Does Competition Curb Exploitation?
4.3 Summary
4.4 Bibliographic Notes
5 Biased Beliefs without Dynamic Inconsistency
5.1 Monopoly Pricing with Over-Optimistic Consumers
5.1.1 Comparison with Related Models
5.2 Overconfidence: Three-Part Tariffs
5.3 Unforeseen Contingencies: Add-On Pricing
5.4 A Summary Exercise: Insurance Markets with Biased Consumers
5.4.1 Equilibrium Analysis when Subjective Beliefs are Observable
5.4.2 Equilibrium Analysis when Subjective Beliefs are Private Information
5.5 Summary
5.6 Bibliographic notes
A Appendix to Part I: A Decision-Theoretic Perspective
A.1 The Multi-Selves Model
A.2 Self-Control Preferences
A.3 The Relation between Self-Control Preferences and the Multi-Selves Model
A.4 Other Classes of Temptation-Driven Preferences
A.5 Bibliographic Notes
II Responding to Market Complexity
6 Sampling-Based Reasoning: Price Competition and Product Differentiation
6.1 A Sampling-Based Choice Procedure
6.2 Price Competition and Technology Adoption
6.2.1 Nash Equilibrium
6.2.2 Welfare Analysis
6.3 Spurious Product Differentiation
6.3.1 Nash Equilibrium
6.3.2 Product Complexity as a Differentiation Device
6.4 Can the Market Educate Consumers?
6.5 Summary
6.6 Bibliographic Notes
7 Sampling-Based Reasoning: Obfuscation
7.1 A Model of Competitive Obfuscation
7.1.1 Nash Equilibrium
7.1.2 Welfare Analysis
7.2 Production Inefficiencies
7.3 Multi-Dimensional Prices
7.4 A Market Intervention: Introducing \Simple" Options
7.5 Summary
7.6 Bibliographic Notes
8 Coarse Reasoning
8.1 A Modeling Framework
8.2 Complex Price Patterns as a Discrimination Device
8.2.1 "DeBruijn" Price Sequences
8.2.2 Conditions for Profitability of Complex Price Patterns
8.3 Limited Understanding of Adverse Selection
8.3.1 A Buyer-Seller Example
8.3.2 A Benchmark: A Bayesian-Rational Buyer
8.3.3 A \Coarse" Buyer
8.3.4 Action-Dependent Feedback
8.4 Summary
8.5 Bibliographic Notes
III Reference Dependence
9 Loss Aversion
9.1 Expected Price as a Reference Point: Monopoly Pricing
9.1.1 Reduced Price Variability
9.1.2 Impact on Expected Prices
9.2 Price Uniformity in a Duopoly Setting: \Kinked" Demand
9.3 Expected Consumption as a Reference Point: An \Attachment Effect"
9.3.1 Personal Equilibrium
9.3.2 Price Randomization
9.4 Discussion
9.4.1 Actual Prices as Reference Points
9.4.2 Pleasant Surprises
9.5 Summary
9.6 Bibliographic Notes
10 Inertia I: Price Competition
10.1 Price Competition under Consumer Inertia
10.2 Price-Frame Competition
10.2.1 Nash Equilibrium
10.2.2 Equilibrium Properties
10.2.3 Two Market Interventions
10.3 Consumer Switching
10.4 Asymmetric Default Assignment
10.5 A Few General Remarks
10.5.1 More than Two Frames
10.5.2 Revealed Preferences
10.6 Summary
10.7 Bibliographic Notes
11 Inertia II: Costly Marketing 261
11.1 A Model of Competitive Marketing
11.2 Nash Equilibrium
11.3 The Effective Marketing Property
11.4 Discussion
11.5 Summary
11.6 Bibliographic Notes
IV Discussion
12 Recurring Themes
12.1 Complex Pricing Strategies
12.2 Spurious Variety
12.3 Market Transactions as a Form of Speculative Trade
12.4 How Effective are Competition and Consumer Protection Policies?
12.5 Externalities between Rational and Boundedly Rational Consumers
12.6 Conclusion
13 But Can't we Get the Same Thing with a Standard Model?
13.1 Rationalization via Modified Information
13.2 Rationalization via Modified Preferences
13.3 Rationalization via Endogenization
13.4 Discussion
13.5 Epilogue
13.6 Bibliographic Notes


Professor of Economics at Tel Aviv University and University College London