Optimal Privacy Regulation When Consumers Make Inferences from Regulatory Policy

Abstract

Consumers often value products whose purchase could also release sensitive data about themselves or otherwise intrude on their privacy. In many cases, consumers do not know exactly how great this privacy risk is, but they can engage in some research to learn more about it. Alternatively, the government can choose to prohibit products that pose sufficiently great privacy risks. Whether or not the government does so will affect both the consumers purchase and research decision. This paper analyses when it is optimal to ban such products when consumers can become informed at a cost. It also compares the regulatory policy of banning products because of their privacy risks to taxing them under the assumption that consumers can make better inferences from bans than taxes. Lastly, the paper analyzes how such regulations might affect ex ante investment incentives.