Using Information about Naivete to Price Discriminate∗

We study the welfare effects of an increase in firms’ information about consumer naivete in a simple reduced-form model in which competitive firms can introduce distortionary fees that naive consumers ignore when making purchase decisions. We establish that our model captures many markets—including those for credit, banking, hotels, gambling, and mobile phones—in which consumer naivete has been invoked as playing an important role. While in natural analogues with rational consumers (we show) seller information about consumers always increases social welfare, we identify arguably weak conditions under which seller information about consumer naivete lowers welfare. When some consumers are naive, a participation distortion arises because the additional profits from naive consumers lead competitive firms to lower transparent prices below cost, and an exploitation distortion arises from the socially costly hidden fees firms charge. Due to seller information about consumer naivete, (i) the participation distortion increases unless the demand curve is sufficiently concave; (ii) the exploitation distortion increases if the social cost of hidden fees satisfies decreasing absolute convexity; and (iii) the interaction of the two effects further lowers social welfare. We also identify conditions under which perfect seller information about consumer naivete hurts both types of consumers.