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Add-on Pricing in Retail Financial Markets and the Fallacies of Consumer Education

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  • Michael Kosfeld
  • Ulrich Schüwer

Abstract

We analyze the consequences of consumer education on prices and welfare in retail financial markets when some consumers are naive about shrouded add-on prices and banks try to exploit this. Allowing for different information and pricing strategies we show that education is unlikely to push banks to full price disclosure, which would be efficient, but instead to a new equilibrium in which banks discriminate between consumer types. Welfare analysis reveals that education, while positive for consumers who learn to make better financial decisions, imposes a negative externality on other consumers when banks respond by setting higher prices. Overall, the welfare effects of consumer education can be negative. Our results identify important pitfalls policy makers should take into account when considering the seemingly harmless intervention of consumer education.

Suggested Citation

  • Michael Kosfeld & Ulrich Schüwer, 2017. "Add-on Pricing in Retail Financial Markets and the Fallacies of Consumer Education," Review of Finance, European Finance Association, vol. 21(3), pages 1189-1216.
    • Handle: RePEc:oup:revfin:v:21:y:2017:i:3:p:1189-1216.
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    File URL: http://hdl.handle.net/10.1093/rof/rfw051
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Gui, Zhengqing & Huang, Yangguang & Zhao, Xiaojian, 2021. "Whom to educate? Financial literacy and investor awareness," China Economic Review, Elsevier, vol. 67(C).
    2. Johannes Johnen, 2020. "Dynamic competition in deceptive markets," RAND Journal of Economics, RAND Corporation, vol. 51(2), pages 375-401, June.
    3. Rasch, Alexander & Thöne, Miriam & Wenzel, Tobias, 2020. "Drip pricing and its regulation: Experimental evidence," Journal of Economic Behavior & Organization, Elsevier, vol. 176(C), pages 353-370.
    4. Herweg, Fabian & Rosato, Antonio, 2018. "Bait and Ditch: Consumer Naiveté and Salesforce Incentives," CEPR Discussion Papers 12612, C.E.P.R. Discussion Papers.
    5. Bello, Piera, 2023. "Gender-based price discrimination in the annuity market: Evidence from Chile," European Economic Review, Elsevier, vol. 151(C).
    6. Alessandro Ispano & Peter Schwardmann, 2023. "Cursed Consumers and the Effectiveness of Consumer Protection Policies," Journal of Industrial Economics, Wiley Blackwell, vol. 71(2), pages 407-440, June.
    7. Zhengqing Gui & Yangguang Huang & Xiaojian Zhao, 2020. "Financial Fraud and Investor Awareness," HKUST CEP Working Papers Series 202002, HKUST Center for Economic Policy.
    8. Tobias Gamp & Daniel Krähmer, 2022. "Competition in search markets with naive consumers," RAND Journal of Economics, RAND Corporation, vol. 53(2), pages 356-385, June.
    9. Murooka, Takeshi & Schwarz, Marco A., 2018. "The timing of choice-enhancing policies," Journal of Public Economics, Elsevier, vol. 157(C), pages 27-40.
    10. Johannes Johnen & Robert Somogyi, 2019. "Deceptive Products on Platforms," Working Papers 19-13, NET Institute.
    11. Marco Savioli & Lorenzo Zirulia, 2020. "Does add-on presence always lead to lower baseline prices? Theory and evidence," Journal of Economics, Springer, vol. 129(2), pages 143-172, March.
    12. Alessandro Ispano & Peter Schwardmann, 2018. "Competition over Cursed Consumers," CESifo Working Paper Series 7046, CESifo.
    13. Gu, Yiquan & Wenzel, Tobias, 2020. "Curbing obfuscation: Empower consumers or regulate firms?," International Journal of Industrial Organization, Elsevier, vol. 70(C).
    14. Gamp, Tobias & Krähmer, Daniel, 2022. "Competition in Search Markets with Naive Consumers," Rationality and Competition Discussion Paper Series 364, CRC TRR 190 Rationality and Competition.
    15. Cornaggia, Kimberly & Hund, John & Nguyen, Giang, 2022. "Investor attention and municipal bond returns," Journal of Financial Markets, Elsevier, vol. 60(C).
    16. Balakina, Olga & Balasubramaniam, Vimal & Dimri, Aditi & Sane, Renuka, 2021. "Unshrouding product-specific attributes through financial education," Working Papers 21/344, National Institute of Public Finance and Policy.

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    More about this item

    Keywords

    Consumer education; Financial literacy; Pricing strategies; Bounded rationality; Welfare effects;
    All these keywords.

    JEL classification:

    • D40 - Microeconomics - - Market Structure, Pricing, and Design - - - General
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • L50 - Industrial Organization - - Regulation and Industrial Policy - - - General

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