‘Protecting Competition to Protect

Consumers’
Does Behavioural Economics Support this Contention?

Joshua Gans
University of Melbourne
The contention
 If consumers can be exploited (i.e., pay for
goods they don’t value enough), won’t market
forces fix this?
 If there is competition, there will be at least
some suppliers who will find it profitable to
actually supply consumers with products they
value.
 So competition protects consumers
The issue …
 Today, Stephen gets asked to give a talk on
regulation on the 18th July and happily
accepts.
 On the 11th July, Stephen wishes he could
defer giving the talk even though nothing has
changed.

 This lack of self control is common.

… it’s even worse …
 Today, Stephen does not anticipate that he
will regret, in July, his decision to give the
talk.

 This is a common failure to anticipate your

future position – it is a naïve approach.
The point …
Outline
 Actual consumer behaviour
 Main result
 Cases
 Credit Card Regulation
 Bundling
 Conclusion
From this week’s The Onion …

LOMPOC, CA—The Bally Total Fitness membership

purchased Monday by Alex Scarbe already appears
destined for failure. "I really should go buy some new
shoes, so I can come back tomorrow and work out,"
Scarbe said, moments after completing the
membership paperwork. "Just getting in here and
signing up is enough for today. I think I'll reward
myself with a smoothie." Scarbe will return to Bally's
twice in April, then once in May to use the whirlpool,
and ultimately cancel his membership in 2007, when
he notices Bally listed on his credit-card statement.
Supplying what they demand
 If consumers lack self-control but are
otherwise sophisticated, firms will offer
products to help them commit
 E.g., low unit price for gym visits
 If consumers lack self-control but are naïve,
firms will exploit this
 E.g., extract payments for automatic renewal fees
Themes
 Demand in a market is based on actual consumer
behaviour.
 For time-based consumption, naïve consumers will place too little
weight on future costs and anticipate getting more value than they
actually receive
 Consumers will purchase today more than they would if they
anticipated their wants in a sophisticated manner
 Over-consumption for any given price
 Competition works to ensure consumers are supplied with
what they demand at a lower price not with what they want.
Welfare Impact
$

Welfare
Loss Supply

Pn

P*

Naïve Demand

Demand

Q* Qn
Impact of reduced competition
$ Supply without competition

Supply with
competition

Pm
Overall welfare is
Pn
increased!
P* Consumer welfare
may not be improved.
Naïve Demand

Demand

Q* Qm Qn
Credit Card Regulation
 RBA concern with rising consumer debt
 Was it a competition concern?
 Theoretical debate
 No significant change since reforms
 Consider actual consumer behaviour
 Naivety implies low fees and high interest rates
 Interchange fees still don’t matter
 Opening up access makes this worse
 Surcharging can help
Bundling and add-on pricing
 Buy one product (hotel, groceries) and then buy
another (phone calls, petrol)
 Consumer reaction
 Sophisticated consumers anticipate add-on prices and
substitute away (benefit of lower price for initial good)
 Naïve consumers do not anticipate prices and over-
consume
 Firms price first good low and naives cross-subsidise
sophisticates
 Suspicious of bundling without any efficiency or
value rationale.
Education
 Under monopoly,
 May have incentive to educate naives if don’t
want to price discriminate against them
 Under competition,
 If educate a naïve, then they learn to substitute
away – go to another firm and receive cross
subsidy
 No incentive for a firm to educate
 Education is a public good
Conclusions
 Implication of behavioural economics: cannot rely on
competition to protect naïve consumers
 Difficult to exercise consumer choice
 Competition generates more supply of things they don’t want
 Education and information are public goods (under-provision
in market place)
 Regulators should focus attention on undesirable practices
 E.g., disconnection fees, automatic renewal fees, unbundling
 Critical for future issues such as cross-media ownership
Paternalism (Rabin)
 What practices are candidates for ACCC
scrutiny?
 Weak rule: if eliminating the practice won’t
hurt rational consumers but will help others
then eliminate.
 Weaker rule: eliminate practices for which
there exists no theoretical profit-maximising
justification when consumers are rational.