Competitive pricing and quality disclosure to cursed consumers

We study the disclosure decision and price-setting behavior of competing firms in the presence of cursed consumers, who fail to be sufficiently skeptical about a firm’s quality upon observing non-disclosure of quality-relevant information. We show that neither competition nor the presence of sophisticated consumers necessarily offer protection to cursed consumers. Exploitation arises if markets are vertically differentiated, if there are many sophisticated consumers, and if it is more likely ex ante that product quality is high. Information campaigns that seek to educate consumers may encourage exploitation and decrease social welfare. Mandatory disclosure laws restore efficiency, but at the cost of redistributing rents from consumers to firms. Our simple model delivers a rich set of positive results, captures important markets, like those for food and consumer finance, and speaks to several recent policy initiatives aimed at consumer protection.