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WORKING PAPERS





The Market for Deceptive ProductsAbstract:

We analyze conditions facilitating profitable deception and incentives for innovation in a model of price competition in homogenous products, where each product has an "additional price" firms can shroud from naive consumers, and there is a floor on the product's up-front price. We show that the incentive to unshroud the additional prices and undercut competitors is limited by the consideration that it reveals how expensive the product is and thereby lowers demand, so that a profitable deceptive equilibrium can often be maintained by firms. If the product is socially valuable and there are sufficiently many firms in the industry, at least one is willing to unshroud, eliminating the deceptive equilibrium. But perversely, if the product is socially wasteful, unshrouding would eliminate the industry, so in this case a profitable deceptive equilibrium always exists. In a market with multiple products, a superior product both diverts sophisticated consumers and renders an inferior product socially wasteful in comparison, so firms can always make profits on the inferior product by selling it in deceptive ways. Because learning ways to charge consumers higher additional prices increases profits from shrouding and lowers competitors' incentive to unshroud, a firm may have a motive to make such exploitative innovations and pass them to its competitors. In contrast, the incentives for innovations that increase the product's value to consumers are strong only in a socially wasteful industry.

(with Paul Heidhues and Takeshi Murooka). Revised May 2012.





A Model of Focusing in Economic ChoiceAbstract:

We present a generally applicable theory of focusing based on the hypothesis that a person focuses more on, and hence overweights, attributes in which her options differ more. Our model predicts that the decisionmaker is too prone to choose options with concentrated advantages relative to alternatives, but maximizes utility when the advantages and disadvantages of alternatives are equally concentrated. In intertemporal choice, the decisionmaker exhibits present bias and time inconsistency when -- such as in lifestyle choices and other widely invoked applications of hyperbolic discounting -- the future costs of current misbehavior are distributed over many dates, and the effects of multiple decisions accumulate. But unlike in previous models, (1) present bias is lower when the costs of current misbehavior are less dispersed, helping to explain why individuals respond more to monetary incentives than to health concerns in harmful consumption; and (2) time inconsistency is lower when the ex-ante choice integrates fewer decisions with accumulating effects. In addition, the agent does not fully maximize welfare even when making decisions ex ante: (3) she commits to too much of an activity -- e.g., exercise or work -- that is beneficial overall; and (4) makes "future-biased" commitments when -- such as in preparing for a big event -- the benefit of many periods' effort is concentrated in a single goal.

(with Ádám Szeidl). Revised March 2012. Older version.





Regular Prices and SalesAbstract:

We study the properties of a profit-maximizing monopolist's optimal price distribution when selling to a loss-averse consumer, where (following Kőszegi and Rabin (2006)) we assume that the consumer's reference point is her recent rational expectations about the purchase. If it is close to costless for the consumer to observe the realized price of the product, the monopolist chooses low and variable "sale" prices with some probability and a high and sticky "regular" price with the complementary probability---a pattern that is consistent with several recently documented facts regarding supermarket pricing. Realizing that she will buy at the sale prices and hence that she will purchase with positive probability, the consumer chooses to avoid the painful uncertainty in whether she will get the product by buying also at the regular price. If it is more costly for the consumer to observe the realized price, a sale is less tempting and hence less effective in generating an expectation to buy with positive probability, so that the monopolist chooses a sticky price and holds no sales---a pattern that is consistent with the pricing behavior of some other retailers (e.g. movie theaters). We also show that ex-ante competition for loyal consumers leads to sticky pricing while ex-post competition leads to marginal-cost pricing, and discuss several other extensions of the model.

(with Paul Heidhues). Revised November 2010.





Price-Sensitive PreferencesAbstract:

One of the foundational assumptions of neoclassical economics is that individual choice behavior reflects underlying stable preferences. A crucial implication of this assumption is that willingness to pay for a product is independent of the prices consumers face for the product at the moment. We test this implication by using the Becker-DeGroot-Marschak procedure, a widely used experimental method to measure individuals’ valuations for consumption goods and other experiences. This procedure allows us to vary the possible prices for a given product across participants, while at the same time eliciting preferences in an incentive compatible manner. We find that valuations for simple goods (mugs and chocolates) are extremely sensitive to the shape of the price distribution: They are several times higher when the price distribution is skewed to the right than when it is skewed to the left. We also show that this sensitivity is not due to participants’ inferences about the value of the good made from the price distribution. Based on these findings, we demonstrate that neoclassical estimates of the elasticity of demand, consumer welfare, and the excess burden from market intervention—estimates that depend heavily on preference stability—can be systematically biased. Finally, since our results pose a problem for measurement of preferences and their welfare implications, we introduce two variants of the basic procedure, and find that these approaches can substantially reduce the dependency of valuations on the price distribution.

(with Nina Mazar and Dan Ariely). Revised August 2009.





A Failure of the No-Arbitrage PrincipleAbstract:

Underlying the principle of no arbitrage is the assumption that markets eliminate any opportunity for risk-free profits. In contrast, we document a pricing mistake by a $200 million company that allowed investors a guaranteed return of 25.6% in a few days, and that resulted in less than $60,000 being invested into exploiting the opportunity.

(with Kristóf Madarász and Máté Matolcsi). Appendix. Revised September 2007.