Shrouded Attributes, Consumer Myopia, and Information Suppression in Competitive Markets

Abstract

Bayesian consumers infer that hidden add-on prices (e.g., the cost of ink for a printer) are likely to be high prices. If consumers are Bayesian, firms will not shroud information in equilibrium. However, shrouding may occur in an economy with some myopic (or unaware) consumers. Such shrouding creates an inefficiency, which firms may have an incentive to eliminate by educating their competitors' customers. However, if add-ons have close substitutes, a "curse of debiasing" arises, and firms will not be able to profitably debias consumers by unshrouding add-ons. In equilibrium, two kinds of exploitation coexist. Optimizing firms exploit myopic consumers through marketing schemes that shroud high-priced add-ons. In turn, sophisticated consumers exploit these marketing schemes. It is not possible to profitably drive away the business of sophisticates. It is also not possible to profitably lure either myopes or sophisticates to nonexploitative firms. We show that informational shrouding flourishes even in highly competitive markets, even in markets with costless advertising, and even when the shrouding generates allocational inefficiencies. Copyright (c) 2006 by the President and Fellows of Harvard College and the Massachusetts Institute of Technology..

Advertising Expensive Mortgages

“…Our paper is also related to the literature on firms' responses to consumers' limited ability to process information and consumer biases (e.g., DellaVigna and Malmendier (2006)). For example, Gabaix and Laibson (2006) and Bordalo, Gennaioli, and Shleifer (2013) show how consumers focus on salient product features, especially if they are financially less literate. 25 Our findings are consistent with their evidence since we find a larger effect of advertising on mortgage prices for less educated consumers.…”

“…In addition, mortgage advertisements contain very little information on the characteristics of mortgages or lenders. Models consistent with this feature of advertising are those in which some characteristics of goods, in our case the reset rate, are shrouded or not salient (Gabaix and Laibson (2006), Bordalo, Gennaioli, and Shleifer (2013)), while advertising is used to increase the salience of other characteristics, in our case the initial interest rate. Finally, the positive correlation between advertising intensity and pricing is driven by mortgage advertisers who tilt their portfolio toward less educated borrowers, minority borrowers, and the poor groups of borrowers identified in the literature as potentially less sophisticated (Agarwal and Ambrose (2011)).…”

The market, competition, and structural exploitation

“…Taking advantage of information asymmetries is also an option. Consider the case of cheaply offering a base good while reaping profits from costly add-ons; the typical example being affordable printers combined with expensive ink cartridges (Gabaix & Laibson, 2006). Or, finally, taking advantage of negative externalities is also a possible strategy: producing a good may create toxic waste that is expensive to dispose of properly, so imposing these costs on unrelated third parties, who are often in a vulnerable position due to their geographical or temporal dispersion, is another way of benefitting unfairly (Reiff, 2013, p. 117).…”

Understanding the Human Factor of the Energy Transition: Mechanisms Underlying Energy-Relevant Decisions and Behaviors

“…Gabaix and Laibson (2006) analyze pricing with boundedly rational consumers who do not pay attention to hidden features of product prices, which they refer to as"add-on"costs. This finding is supported by recent empirical evidence that people are inattentive to ancillary product costs such as sales taxes (Chetty et al, 2009), shipping and handling charges (Hossain and Morgan, 2006), or out-of-pocket insurance costs (Abaluck and Gruber, 2011).…”