Competition and Consumer Confusion
In many markets consumer biases do not affect prices, since competition forces firms to price their products close to marginal cost; competition protects the consumer. We show that noisy consumer product evaluations undermine the force of competition, enabling firms to charge high mark-ups in equilibrium, even in highly competitive environments. We analyze markets in which rational firms sell goods to consumers who evaluate products with noise. Using results from extreme value theory, we show that competition generally has a remarkably weak impact on markups. For normally distributed evaluation noise, we show that markups are proportional to the inverse of the square root of log(n), where n is the number of competitors. In this setting, a highly competitive industry with n=1,000,000 firms will retain 1/3 of the markup of a highly concentrated industry with only n=10 competitors. When we make noise an endogenous variable, we find that firms choose excess noise by making their products inefficiently confusing. Moreover, competition exacerbates this effect: a higher degree of competition causes firms to choose even more excess complexity. Firms with lower intrinsic quality and higher production costs choose the most excess complexity. Educating consumers to reduce their evaluation noise would generate large welfare gains. But the gains accrue mostly to the consumer, so firms can't profitably educate consumers and steal them away from competitors. Finally, we introduce an econometric framework that measures bounded rationality and confusion in the marketplace
|Date of creation:||11 Aug 2004|
|Date of revision:|
|Contact details of provider:|| Phone: 1 212 998 3820|
Fax: 1 212 995 4487
Web page: http://www.econometricsociety.org/pastmeetings.asp
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Sendhil Mullainathan & Andrei Shleifer, 2005.
"The Market for News,"
American Economic Review,
American Economic Association, vol. 95(4), pages 1031-1053, September.
- Roland Bénabou & Robert Gertner, 1993. "Search with Learning from Prices: Does Increased Inflationary Uncertainty Lead to Higher Markups?," Review of Economic Studies, Oxford University Press, vol. 60(1), pages 69-93.
- Sendhil Mullainathan & Andrei Shleifer, 2002.
Harvard Institute of Economic Research Working Papers
1981, Harvard - Institute of Economic Research.
- Malmendier, Ulrike M. & Della Vigna, Stefano, 2003.
"Overestimating Self-Control: Evidence from the Health Club Industry,"
1800, Stanford University, Graduate School of Business.
- Stefano DellaVigna & Ulrike Malmendier, 2004. "Overestimating Self_Control: Evidence from the Health Club Industry," NBER Working Papers 10819, National Bureau of Economic Research, Inc.
- Malmendier, Ulrike M. & Della Vigna, Stefano, 2002. "Overestimating Self-Control: Evidence from the Health Club Industry," Research Papers 1880, Stanford University, Graduate School of Business.
- Ali Hortacsu & Chad Syverson, 2003. "Product Differentiation, Search Costs, and Competition in the Mutual Fund Industry: A Case Study of the S&P 500 Index Funds," NBER Working Papers 9728, National Bureau of Economic Research, Inc.
- Perloff, Jeffrey M & Salop, Steven, 1984.
"Equilibrium with product differentiation,"
Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series
qt4cq0m6s3, Department of Agricultural & Resource Economics, UC Berkeley.
- Anderson, S. P. & De Palma, A. & Nesterov, Y., .
"Oligopolistic competition and the optimal provision of products,"
CORE Discussion Papers RP
1179, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- Anderson, Simon P & de Palma, Andre & Nesterov, Yurii, 1995. "Oligopolistic Competition and the Optimal Provision of Products," Econometrica, Econometric Society, vol. 63(6), pages 1281-1301, November.
- ANDERSON, Simon P. & DE PALMA, André & NESTEROV, Yurii, 1994. "Oligopolistic Competition and the Optimal Provision of Products," CORE Discussion Papers 1994034, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
- Rosenthal, Robert W, 1980. "A Model in Which an Increase in the Number of Sellers Leads to a Higher Price," Econometrica, Econometric Society, vol. 48(6), pages 1575-79, September.
- Kenneth L. Judd & Michael H. Riordan, 1994. "Price and Quality in a New Product Monopoly," Review of Economic Studies, Oxford University Press, vol. 61(4), pages 773-789.
- Ali Hortaçsu & Chad Syverson, 2004. "Product Differentiation, Search Costs, and Competition in the Mutual Fund Industry: A Case Study of S&P 500 Index Funds," The Quarterly Journal of Economics, Oxford University Press, vol. 119(2), pages 403-456.
When requesting a correction, please mention this item's handle: RePEc:ecm:nasm04:663. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christopher F. Baum)
If references are entirely missing, you can add them using this form.