Seemingly Exploitative Contracts

40 Pages Posted: 29 Aug 2018 Last revised: 16 Mar 2021

See all articles by Pei Cheng Yu

Pei Cheng Yu

UNSW Australia Business School, School of Economics

Date Written: August 20, 2018

Abstract

This paper studies sequential price discrimination of sophisticated present-biased consumers in the credit market. The optimal contract utilizes present bias to improve screening by inducing certain consumers to over-consume and over-accumulate debt. This shows that the optimal contract can have features that seem exploitative. In essence, these features cause certain consumers to experience ex-post welfare losses even when they are sophisticated. If the intention of firms is to screen and not exploit consumers, then financial regulations aimed at protecting consumers by eliminating seemingly exploitative features could introduce additional distortions. In contrast, contracts that are truly exploitative induce over-consumption and over-accumulation of debt by taking advantage of the incorrect beliefs of non-sophisticated consumers.

Keywords: Credit contract, Financial regulations, Non-linear pricing, Present bias, Sequential screening

JEL Classification: D18, D82, D86, G28

Suggested Citation

Yu, Pei Cheng, Seemingly Exploitative Contracts (August 20, 2018). UNSW Economics Working Paper 2018-15, Journal of Economic Behavior and Organization, Vol. 176, 2020, Available at SSRN: https://ssrn.com/abstract=3235235 or http://dx.doi.org/10.2139/ssrn.3235235

Pei Cheng Yu (Contact Author)

UNSW Australia Business School, School of Economics ( email )

High Street
Sydney, NSW 2052
Australia

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