Consumer confusion, obfuscation and price regulation

AuthorTobias Wenzel,Yiquan Gu
DOIhttp://doi.org/10.1111/sjpe.12121
Published date01 May 2017
Date01 May 2017
CONSUMER CONFUSION,
OBFUSCATION AND PRICE
REGULATION
Yiquan Gu* and Tobias Wenzel**
,
***
ABSTRACT
This paper studies firms’ obfuscation choices in a duopoly setting where two
firms differ in their marginal costs of production. We show that the high-cost
firm chooses maximum obfuscation while the low-cost firm chooses minimal
(maximal) obfuscation if the cost advantage is large (small). We argue that in
this setting there is a new role for price regulation as it leads to more transpar-
ent pricing. Moreover, a price cap benefits social welfare as it shifts production
to the more efficient low-cost firm.
II
NTRODUCTION
For markets and competition to work, well-informed consumers are essential.
1
The degree of information and transparency in a market and, hence, the envi-
ronment under which consumers make their purchase decisions can be heavily
influenced by firm strategy. For instance, by deliberately increasing the complex-
ity of price structure or price presentation, firms may make consumers’ decision
processes harder. Such strategies by firms with the intent of confusing con-
sumers have commonly been termed obfuscation (Ellison and Ellison, 2009).
The aim of this paper is to understand firms’ incentives to obfuscate in a
setting where firms differ in their (marginal) costs of production and the
effects of price regulation. The question is whether low efficiency firms can use
obfuscation tactics to hide their high costs. To this end, we develop a duopoly
model where two heterogeneous firms compete to supply a homogeneous
product. There are two types of consumers: sophisticated and naive con-
sumers. Sophisticated consumers can perfectly evaluate the firms’ offers and
pick the better one. Naive consumers are not able to compare the two offers,
and thus randomly choose one of the two offers.
*University of Liverpool
**University of Bath
***D
usseldorf Institute for Competition Economics (DICE)
1
Imperfect consumer decision making has been documented in many markets, such as
retail financial markets (Campbell, 2006), telecommunication markets (Miravete, 2013) and
electricity markets (Wilson and Waddams, 2010), among others.
Scottish Journal of Political Economy, DOI: 10.1111/sjpe.12121, Vol. 64, No. 2, May 2017
©2016 Scottish Economic Society.
169
By obfuscation, firms can increase the number of naive consumers in the
market. In practice, this could be the use of different price formats or terms
and language which makes it harder for some consumers to fully understand
pricing and, hence, impedes comparisons between different offers. For example,
although in many countries supermarkets are required to display unit prices
for groceries, in reality, ‘[unit prices] were often not being displayed on multi-
buys or promotions, and different units were used for varieties of the same pro-
duct, making them extremely difficult to compare’.
2
The retail financial indus-
try is also known for using obfuscation tactics to disorient consumers.
3
Alternatively, an increase in obfuscation might also correspond to the number
of price elements (as in mobile phone contracts) which may also make it harder
for consumers to evaluate different offers and pick the best deal.
4
We show that the high-cost firm always benefits from more naive consumers.
Hence, this firm chooses to obfuscate as much as possible. In contrast, the low-
cost firm has ambiguous preferences towards the share of naive consumers. On
the one hand, more transparency hurts the firms as pricing becomes more com-
petitive. On the other hand, due to its lower production costs, this firm has an
advantage in competing for sophisticated consumers. This second effect is stron-
ger the larger the cost advantage is. As a result, the more efficient firm chooses
to obfuscate as much as possible if the cost advantage is small, but chooses not
to obfuscate at all if its cost advantage is sufficiently large.
On the policy front, this paper argues that imposing a price cap can be an
effective measure of consumer protection in this context. We show that intro-
ducing a price cap is beneficial for consumers for two reasons. First, there is
an immediate positive impact as pricing by firms becomes more competitive.
However, there is a second and more important positive effect which works
via the obfuscation decisions. Due to the introduction of the price cap, the
low-cost firm may choose not to obfuscate anymore. The reason is that serv-
ing the naive consumers has become a less attractive option and competing
for the sophisticated consumers a relatively more attractive option. As a con-
sequence, the low-cost firm which has an advantage in attracting sophisticated
consumers may prefer to stop obfuscating. Thus, in the current set-up, a price
cap has the new role of leading to more transparent pricing.
Importantly, beneficial effects of price regulation also extend to social wel-
fare. We show that with more competitive pricing from both firms, the proba-
bility that the high-cost firm’s price is lower decreases. This shifts the demand
of sophisticated consumers from the high-cost firm to the low-cost firm and
hence, improves social welfare. Moreover, when a price cap reduces obfusca-
tion, more consumers become sophisticated and are able to buy from the
2
See the Guardian report by Smithers (2011) who cites the research done by the consumer
campaigning charity Which?. Piccione and Spiegler (2012) and Chioveanu and Zhou (2013)
provide theoretical treatments of this approach.
3
See, for example, Carlin and Manso (2011) who study the interaction between obfusca-
tion and investor sophistication in mutual fund markets.
4
Spiegler (2006) considers a set-up where consumers are confused by a multitude of price
dimensions. In addition, firms may also shroud certain price elements. See, for example,
Gabaix and Laibson (2006).
170 YIQUAN GU AND TOBIAS WENZEL
Scottish Journal of Political Economy
©2016 Scottish Economic Society

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