The impact of competition on prices with numerous firms

Gabaix, Xavier; Laibson, David; Li, Deyuan; Li, Hongyi; Resnick, Sidney I.; Vries, Casper G. de

doi:10.1016/j.jet.2016.04.001

Cited by 66 publications

(51 citation statements)

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“…Adding a second firm with a differentiated product to the market can increase prices. Similarly, Gabaix et al () show in a homogeneous‐product market with a random‐utility model that firms can sustain large markups even with a large number of competitors. In both models, demand curvature can mitigate pricing pressure of competitors and prevent rent‐shifting to consumers.…”

Section: Related Literaturementioning

confidence: 88%

Automatic‐renewal contracts with heterogeneous consumer inertia

Johnen

2019

Economics Manag Strategy

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Automatic contract renewals are a common feature in consumer markets. Since these contracts renew automatically unless a consumer actively cancels, firms can use them to exploit consumer inertia. As a source of inertia I study limited attention and investigate how firms use contract renewal to sell to consumers with different degrees of inattention. In monopolistic markets, adverse selection of more‐attentive consumers limits the exploitation of naively inattentive consumers. When signing a contract, naively inattentive consumers overestimate their future probability to make an active cancellation decision. To exploit this mistake, the monopolist wants to target these consumers with large prices after contracts renew. These back‐loaded contracts, however, adversely attract more‐attentive consumers who cancel more often when choosing these exploitative contracts. To mitigate adverse selection, monopolists focus less on exploiting naively inattentive consumers. Adverse selection induces fewer consumer mistakes and can increase efficiency. I show that competition mitigates adverse selection, which induces firms to focus more on exploitation with more back‐loaded pricing. I discuss implications for recently implemented policies on automatic‐renewal contracts.

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Section: Related Literaturementioning

confidence: 88%

Automatic‐renewal contracts with heterogeneous consumer inertia

Johnen

2019

Economics Manag Strategy

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“…A firm can also introduce noise or complexity into its marketing (Carlin, 2009;Gabaix et al, 2016) to induce some potential customers to overestimate the quality or underestimate the price of the firm's products (e.g., a mutual fund advertisement that implies without evidence that active management is superior to passive management).…”

Section: Product Designmentioning

confidence: 99%

“…Grinblatt et al (2016) find that high-IQ investors choose cheaper mutual funds. Gabaix et al (2016) show that competition only weakly drives down equilibrium markups in markets where consumers make random evaluation errors. …”

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confidence: 93%

Behavioral Household Finance

Beshears

Choi

Laibson

et al. 2018

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This chapter provides an overview of household finance. The first part summarizes key facts regarding household financial behavior, emphasizing empirical regularities that are inconsistent with the standard classical economic model and discussing extensions of the classical model and explanations grounded in behavioral economics that can account for the observed patterns. This part covers five topics: consumption and savings, borrowing, payments, asset allocation, and insurance. The second part addresses interventions that firms, governments, and other parties deploy to shape household financial outcomes: education and information, peer effects and social influence, product design, advice and disclosure, choice architecture, and interventions that directly target prices or quantities. This chapter is divided into two parts, each of which is further divided into several sections. The first part summarizes key facts regarding household financial behavior, emphasizing empirical regularities that are inconsistent with the standard classical economic model and discussing both extensions of the classical model and explanations grounded in behavioral economics that can account for the observed patterns. This part covers five topics: (I) consumption and savings, (II) borrowing, (III) payments, (IV) asset allocation, and (V) insurance. The second part addresses interventions that firms, governments, and other parties deploy to shape household financial outcomes: (VI) education and information, (VII) peer effects and social influence, (VIII) product design, (IX) advice and disclosure, (X) choice architecture, and (XI) interventions that directly target prices or quantities. The final section of the paper (XII) concludes. John BeshearsWe offer broad coverage of the household finance literature, but we limit the scope of our discussion along some dimensions. We focus on the U.S. institutional context and on empirical work based on U.S. data, although we do bring evidence from other wealthy countries to bear when germane and occasionally reference evidence from developing countries. We address household asset allocation but do not draw out its implications for asset pricing, which are covered by the asset pricing chapter in this handbook. Although household decisions regarding health care are relevant to household finance, we largely omit this literature from our chapter because it is covered in depth in the chapter on behavioral health economics. Finally, there is some overlap between our section on financial product design and the chapter on behavioral industrial organization; we refer readers to that chapter for related material on that topic. Part 1: Facts I. Consumption and SavingsBeginning with the seminal work of Modigliani and Brumberg (1954) and Friedman (1957), economists have embraced the view that households choose to save and borrow to smooth consumption over the lifecycle. Intuitively, if agents have concave utility functions over consumption, then they should spread consumption across time to optimally...

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“…Moreover, the theory of differentiated product competition suggests that there is no reason to expect that increasing the number of competitors will lower prices towards costs (Gabaix, Laibson, Li, Li, Resnick and de Vries, 2013). However, we should expect firms to exacerbate consumer confusion about quality through persuasive advertising or other means, and to exacerbate consumer confusion about prices through obfuscation.…”

Section: Consumer Confusionmentioning

confidence: 99%

“…In particular, if care is taken to adjust welfare calculations, the noise in random utility models may be interpreted as error in product evaluation rather than as true variation in tastes. Importantly, if consumers misperceive homogeneous goods to be differentiated, there is no reason to expect that increasing the number of competitors will lower prices towards costs (Gabaix et al, 2013).…”

Section: Imaginary Quality Differencesmentioning

confidence: 99%

Failing to Choose the Best Price: Theory, Evidence, and Policy

Grubb

2015

Rev Ind Organ

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Both the "law of one price" and Bertrand's (1883) prediction of marginal cost pricing for homogeneous goods rest on the assumption that consumers will choose the best price. In practice, consumers often fail to choose the best price because they search too little, become confused comparing prices, and then show excessive inertia through too little switching away from past choices or default options. This is particularly true when price is a vector rather than a scalar, and consumers have limited experience in the relevant market. All three mistakes may contribute to positive markups that fail to diminish as the number of competing sellers increases. Firms may have an incentive to exacerbate these problems by obfuscating prices, thereby using complexity to make price comparisons difficult and soften competition. Possible regulatory interventions include simplifying the choice environment, for instance by restricting price to be a scalar, advising consumers of their expected costs under each option, or choosing on behalf of consumers. * Boston College, michael.grubb@bc.edu, https://www2.bc.edu/michael-grubb/. I am grateful to Mark Armstrong, Ben Handel, and Rani Spiegler for careful reading and many helpful comments on an earlier draft. I also thank Vera Sharunova for her excellent research assistance.

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The impact of competition on prices with numerous firms

Abstract: This paper describes a mechanism that sustains high markups, even in markets with homogenous goods and many competing firms. We show that random utility models with idiosyncratic taste shocks driven by standard noise distributions produce, in large

Cited by 66 publications

References 66 publications

Automatic‐renewal contracts with heterogeneous consumer inertia

Automatic‐renewal contracts with heterogeneous consumer inertia

Behavioral Household Finance

Failing to Choose the Best Price: Theory, Evidence, and Policy

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