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Naïveté-Based Discrimination

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  • Paul Heidhues
  • Botond Kőszegi

Abstract

We initiate the study of naïveté-based discrimination, the practice of conditioning offers on external information about consumers’ naïveté. Knowing that a consumer is naive increases a monopolistic or competitive firm's willingness to generate inefficiency to exploit the consumer's mistakes, so naïveté-based discrimination is not Pareto-improving, can be Pareto-damaging, and often lowers total welfare when classical preference-based discrimination does not. Moreover, the effect on total welfare depends on a hitherto unemphasized market feature: the extent to which the exploitation of naive consumers distorts trade with different types of consumers. If the distortion is homogeneous across naive and sophisticated consumers, then under an arguably weak and empirically testable condition, naïveté-based discrimination lowers total welfare. In contrast, if the distortion arises only for trades with sophisticated consumers, then perfect naïveté-based discrimination maximizes social welfare, although imperfect discrimination often lowers welfare. If the distortion arises only for trades with naive consumers, then naïveté-based discrimination has no effect on welfare. We identify applications for each of these cases. In our primary example, a credit market with present-biased borrowers, firms lend more than is socially optimal to increase the amount of interest naive borrowers unexpectedly pay, creating a homogeneous distortion. The condition for naïveté-based discrimination to lower welfare is then weaker than prudence.

Suggested Citation

  • Paul Heidhues & Botond Kőszegi, 2017. "Naïveté-Based Discrimination," The Quarterly Journal of Economics, Oxford University Press, vol. 132(2), pages 1019-1054.
  • Handle: RePEc:oup:qjecon:v:132:y:2017:i:2:p:1019-1054.
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    File URL: http://hdl.handle.net/10.1093/qje/qjw042
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    References listed on IDEAS

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    1. Thesis Thursday: Alastair Irvine
      by Chris Sampson in The Academic Health Economists' Blog on 2019-03-21 07:00:35

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    More about this item

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D49 - Microeconomics - - Market Structure, Pricing, and Design - - - Other
    • D69 - Microeconomics - - Welfare Economics - - - Other
    • L19 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Other

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