Bounded Rationality and Industrial Organization

Paperback | January 2, 2014

byRan Spiegler

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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 comparecomplicated 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 toexamine 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 microeconomictheory, 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 ofdefault 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 andIndustrial 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.

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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 comparecomplicated products. Thus the standard model ...

Ran Spiegler is Professor of Economics at Tel Aviv University and University College London.
Format:PaperbackDimensions:240 pages, 9.21 × 6.14 × 0.68 inPublished:January 2, 2014Publisher:Oxford University PressLanguage:English

The following ISBNs are associated with this title:

ISBN - 10:0199334269

ISBN - 13:9780199334261

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Table of Contents

1. Introduction1.1 Bibliographic NotesI Anticipating Future Preferences2. Dynamically Inconsistent Preferences I: Unconstrained Contracting2.1 The Multi-Selves Model2.1.1 Naivety2.2 Monopoly Pricing2.2.1 Optimal Price Schemes for Sophisticated Consumers2.2.2 Optimal Price Schemes for Naive Consumers2.2.3 Screening the Consumer's Type2.3 Competitive Pricing2.4 Welfare Analysis2.5 Educating Naive Consumers2.6 The Interpretation of Naivety2.7 Two Applications2.8 Other Topics2.8.1 The (?, ?) Model2.8.2 Preference Heterogeneity2.9 Summary2.10 Bibliographic Notes3. Dynamically Inconsistent Preferences II: Constrained Contracting3.1 Two-Part Tariffs3.1.1 Departure from Marginal-Cost Pricing3.1.2 Welfare Analysis3.2 Destabilization of Commitment Devices: Renegotiation and Spot Market Competition3.3 Self-Control3.3.1 Implications for Monopoly Pricing3.3.2 Do Self-Control Costs Hamper Competition?3.4 Summary3.5 Bibliographic Notes4. Dynamically Inconsistent Preferences III: Partial Naivety4.1 Magnitude Naivety4.1.1 Monopoly Pricing4.1.2 Are More Sophisticated Consumers Always Better Off?4.2 Frequency Naivety4.2.1 First-Best Monopoly Pricing4.2.2 Second-Best Monopoly Pricing4.2.3 Does Competition Curb Exploitation?4.3 Summary4.4 Bibliographic Notes5. Biased Beliefs without Dynamic Inconsistency5.1 Monopoly Pricing with Over-Optimistic Consumers5.1.1 Comparison with Related Models5.2 Overconfidence: Three-Part Tariffs5.3 Unforeseen Contingencies: Add-On Pricing5.4 A Summary Exercise: Insurance Markets with Biased Consumers5.4.1 Equilibrium Analysis when Subjective Beliefs are Observable5.4.2 Equilibrium Analysis when Subjective Beliefs are Private Information5.5 Summary5.6 Bibliographic notesA. Appendix to Part I: A Decision-Theoretic PerspectiveA.1 The Multi-Selves ModelA.2 Self-Control PreferencesA.3 The Relation between Self-Control Preferences and the Multi-Selves ModelA.4 Other Classes of Temptation-Driven PreferencesA.5 Bibliographic NotesII Responding to Market Complexity6. Sampling-Based Reasoning: Price Competition and Product Differentiation6.1 A Sampling-Based Choice Procedure6.2 Price Competition and Technology Adoption6.2.1 Nash Equilibrium6.2.2 Welfare Analysis6.3 Spurious Product Differentiation6.3.1 Nash Equilibrium6.3.2 Product Complexity as a Differentiation Device6.4 Can the Market Educate Consumers?6.5 Summary6.6 Bibliographic Notes7. Sampling-Based Reasoning: Obfuscation7.1 A Model of Competitive Obfuscation7.1.1 Nash Equilibrium7.1.2 Welfare Analysis7.2 Production Inefficiencies7.3 Multi-Dimensional Prices7.4 A Market Intervention: Introducing "Simple" Options7.5 Summary7.6 Bibliographic Notes8. Coarse Reasoning8.1 A Modeling Framework8.2 Complex Price Patterns as a Discrimination Device8.2.1 "DeBruijn" Price Sequences8.2.2 Conditions for Profitability of Complex Price Patterns8.3 Limited Understanding of Adverse Selection8.3.1 A Buyer-Seller Example8.3.2 A Benchmark: A Bayesian-Rational Buyer8.3.3 A \Coarse" Buyer8.3.4 Action-Dependent Feedback8.4 Summary8.5 Bibliographic NotesIII Reference Dependence9. Loss Aversion9.1 Expected Price as a Reference Point: Monopoly Pricing9.1.1 Reduced Price Variability9.1.2 Impact on Expected Prices9.2 Price Uniformity in a Duopoly Setting: "Kinked" Demand9.3 Expected Consumption as a Reference Point: An "Attachment Effect"9.3.1 Personal Equilibrium9.3.2 Price Randomization9.4 Discussion9.4.1 Actual Prices as Reference Points9.4.2 Pleasant Surprises9.5 Summary9.6 Bibliographic Notes10. Inertia I: Price Competition10.1 Price Competition under Consumer Inertia10.2 Price-Frame Competition10.2.1 Nash Equilibrium10.2.2 Equilibrium Properties10.2.3 Two Market Interventions10.3 Consumer Switching10.4 Asymmetric Default Assignment10.5 A Few General Remarks10.5.1 More than Two Frames10.5.2 Revealed Preferences10.6 Summary10.7 Bibliographic Notes11. Inertia II: Costly Marketing 26111.1 A Model of Competitive Marketing11.2 Nash Equilibrium11.3 The Effective Marketing Property11.4 Discussion11.5 Summary11.6 Bibliographic NotesIV Discussion12. Recurring Themes12.1 Complex Pricing Strategies12.2 Spurious Variety12.3 Market Transactions as a Form of Speculative Trade12.4 How Effective are Competition and Consumer Protection Policies?12.5 Externalities between Rational and Boundedly Rational Consumers12.6 Conclusion13. But Can't we Get the Same Thing with a Standard Model?13.1 Rationalization via Modified Information13.2 Rationalization via Modified Preferences13.3 Rationalization via Endogenization13.4 Discussion13.5 Epilogue13.6 Bibliographic NotesBibliographyIndex