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‘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 …

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Actual consumer behaviour Main result Cases
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Credit Card Regulation Bundling


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


Demand in a market is based on actual consumer behaviour.

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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 Pn P*

Overall welfare is increased! Consumer welfare may not be improved.
Naïve Demand Demand Q* Qm Qn

Credit Card Regulation
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RBA concern with rising consumer debt Was it a competition concern?
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Theoretical debate No significant change since reforms Naivety implies low fees and high interest rates Interchange fees still don’t matter Opening up access makes this worse Surcharging can help

Consider actual consumer behaviour
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Bundling and add-on pricing
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Buy one product (hotel, groceries) and then buy another (phone calls, petrol) Consumer reaction
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Sophisticated consumers anticipate add-on prices and substitute away (benefit of lower price for initial good) Naïve consumers do not anticipate prices and overconsume

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Firms price first good low and naives cross-subsidise sophisticates Suspicious of bundling without any efficiency or value rationale.


Under monopoly,

May have incentive to educate naives if don’t want to price discriminate against them 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

Under competition,

Education is a public good


Implication of behavioural economics: cannot rely on competition to protect naïve consumers
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Difficult to exercise consumer choice Competition generates more supply of things they don’t want

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Education and information are public goods (under-provision in market place) Regulators should focus attention on undesirable practices
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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.