Add-On Pricing, Naive Consumers, and the Hidden Welfare Costs of Education
Faculty of Economics and Business Administration; Institute for the Study of Labor (IZA); Centre for Economic Policy Research (CEPR); CESifo (Center for Economic Studies and Ifo Institute)
Goethe University Frankfurt - Department of Finance
CEPR Discussion Paper No. DP8636
Previous research shows that firms shroud high add-on prices in competitive markets with naive consumers leading to inefficiency. We analyze the effects of regulatory intervention via educating naive consumers on equilibrium prices and welfare. Our model allows firms to shroud, unshroud, or partially unshroud add-on prices. Results show that consumer education may increase welfare; however, it may also decrease welfare if education is insufficient to alter the equilibrium information and pricing strategy of firms. Educating consumers may do more harm than good and should thus only be considered if the regulator is sufficiently well informed about consumer and firm behavior.
Number of Pages in PDF File: 45
Keywords: bounded rationality, competition, consumer protection, regulation, welfare
JEL Classification: D40, D80, L50working papers series
Date posted: November 24, 2011
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