An economic analysis of internet privacy regulation1

This paper analyzes the rationale for regulation of privacy in two new models of why firms collect consumer information. Prior work has focused on the use of consumer information for price discrimination. In this paper, I consider two different rationales. In the product improvement model, I assume that collecting consumer information allows firms to improve their product. In the supplemental good model, I assume that collecting consumer information allows firms to know which of two additional goods a consumer values. I show that in both models firms tend to offer too much, rather than too little, privacy protection from the point of view of maximizing consumer welfare. In both models, privacy protections soften the competition between firms and lead to higher prices.