Inferior Products and Profitable Deception*

Paul Heidhues, Botond Koszegi and Takeshi Murooka

The Review of Economic Studies, 2017, vol. 84, issue 1, 323-356

Abstract: We analyse conditions facilitating profitable deception in a simple model of a competitive retail market. Firms selling homogenous products set anticipated prices that consumers understand and additional prices that naive consumers ignore unless revealed to them by a firm, where we assume that there is a binding floor on the anticipated prices. Our main results establish that “bad” products (those with lower social surplus than an alternative) tend to be more reliably profitable than “good” products. Specifically, (1) in a market with a single socially valuable product and sufficiently many firms, a deceptive equilibrium—in which firms hide additional prices—does not exist and firms make zero profits. But perversely, (2) if the product is socially wasteful, then a profitable deceptive equilibrium always exists. Furthermore, (3) in a market with multiple products, since a superior product both diverts sophisticated consumers and renders an inferior product socially wasteful in comparison, it guarantees that firms can profitably sell the inferior product by deceiving consumers. We apply our framework to the mutual fund and credit card markets, arguing that it explains a number of empirical findings regarding these industries.

Keywords: Deceptive product; Inferior product; Naivete; Profitable deception; Mutual funds; Credit cards (search for similar items in EconPapers)
JEL-codes: D14 D18 D21 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (81)

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