Paul Heidhues (Visitor from ESMT) will present:

"Naivete-Based Discrimination"

at 12pm on Thursday, April 21, 2016 in 310 Silsby

Abstract

We initiate the study of naivete-based discrimination, the practice of conditioning o ffers on external information about consumers' naivete. Knowing that a consumer is naive increases a
monopolistic or competitive firm's willingness to generate inefficiency to exploit the consumer's mistakes, so naivete-based discrimination is in neither case Pareto-improving, can be Pareto-damaging,
and often lowers total welfare when preference-based discrimination does not. We partially characterize these welfare e ffects, showing that they depend on the "distortionary impact" of naivete-the extent to which the exploitation of naive consumers distorts trades with diff erent types of consumers. If the distortionary impact is homogenous across naive and sophisticated consumers, then under an arguably weak and empirically testable condition, naivete-based discrimination lowers total welfare. In contrast, if the distortionary impact arises only for trades with sophisticated consumers, then perfect naivete-based discrimination maximizes social welfare, although imperfect discrimination often lowers welfare. And if the distortionary impact arises only for trades with naive consumers, then naivete-based discrimination has no eff ect on welfare. We identify applications for each of these cases. In our primary example, a credit market with present-biased borrowers, firms lend more than socially optimal to increase the amount of interest naive borrowers unexpectedly pay, creating a homogenous distortion. The condition for naivete-based discrimination to lower welfare is then weaker than prudence.