Failing to Choose the Best Price: Theory, Evidence, and Policy
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Both the “law of one price” and Bertrand’s (J Savants 67:499–508, 1883) prediction of marginal cost pricing for homogeneous goods rest on the assumption that consumers will choose the best price. In practice, consumers often fail to choose the best price because they search too little, become confused comparing prices, and/or show excessive inertia through too little switching away from past choices or default options. This is particularly true when price is a vector rather than a scalar, and consumers have limited experience in the relevant market. All three mistakes may contribute to positive markups that fail to diminish as the number of competing sellers increases. Firms may have an incentive to exacerbate these problems by obfuscating prices, thereby using complexity to make price comparisons difficult and soften competition. Possible regulatory interventions include: simplifying the choice environment, for instance by restricting price to be a scalar; advising consumers of their expected costs under each option; or choosing on behalf of consumers.
KeywordsBehavioral industrial organization Bounded rationality Search Obfuscation Switching Inertia
JEL ClassificationD43 D83 L11 L13 L15
I am grateful to Mark Armstrong, Ben Handel, and Rani Spiegler for careful reading and many helpful comments on an earlier draft. I also thank Vera Sharunova for her excellent research assistance.
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