DP12612 Bait and Ditch: Consumer Naiveté and Salesforce Incentives

Author(s): Fabian Herweg, Antonio Rosato
Publication Date: January 2018
Keyword(s): Add-On Pricing, Bait and Switch, Consumer Naiveté, Incentive Contracts
JEL(s): D03, D18, D21, L13, M52
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12612

We analyze a model of price competition between a transparent retailer and a deceptive one in a market where a fraction of consumers is naive. The transparent retailer is an independent shop managed by its owner. The deceptive retailer belongs to a chain and is operated by a manager. The retailers sell an identical base product, but the deceptive one also offers an add-on. Rational consumers never consider buying the add-on, yet naive ones can be talked into buying it. By offering its store manager a contract that pushes him to never sell the base good without the add-on, the chain can induce an equilibrium in which both retailers obtain more-than-competitive profits. The equilibrium features market segmentation with the deceptive retailer targeting only naive consumers whereas the transparent retailer serves only rational ones. Welfare is not monotone in the fraction of naive consumers in the market. Hence, policy interventions designed to de-bias naive consumers might backfire.