Add-on Pricing, Consumer Myopia and Regulatory Intervention

This paper analyzes regulatory intervention when firms exploit consumers who are myopic in their decision making. As shown by Gabaix and Laibson (2006), a potential equilibrium price strategy of firms involves excessively high-priced add-ons and shrouding of add-on prices, which leads to a social welfare loss and consumer protection problems. Our model introduces a price discrimination equilibrium, and a regulator who educates myopic consumers about the relevance of add-on prices before firms decide on their pricing strategy. Such efforts to correct individuals’ factual mistakes are largely uncontroversial in politics and the academic literature. In contrast to this view, we show that regulatory intervention via educating consumers can decrease social welfare and weaken consumer protection. This is the case if education efforts are insufficient to change a price equilibrium with high-priced add-ons or with price discrimination.