DP17260 Inflated recommendations
Biased recommendations arise naturally in a market with heterogeneous consumers: a seller offers a product to a mix of consumers who can purchase through an intermediary or directly from a seller. "Picky" consumers are uncertain about match quality, which they observe only after purchase, while "flexible" consumers are always happy with the match. Therefore, picky consumers rely on the intermediary's recommendation. We provide conditions under which the intermediary will recommend a welfare-reducing bad match with positive probability, resulting in inflated recommendations. Regulatory interventions may lead to higher social welfare. However, a regulatory intervention that prohibits recommending bad matches may backfire.