Tobias Gamp (HU Berlin)
Biased Beliefs in Search Markets
Abstract: We study the implications of biased consumer beliefs for search market outcomes. We assume that biased consumers base their search strategy on a belief function which specifies for any (true) distribution of utility offers in the market a possibly incorrect distribution of utility offers. We characterize market outcomes for all belief functions that satisfy certain regularity conditions. In particular, we show that if the belief function is non-pessimistic, a novel type of equilibrium may emerge in which firms make penny sales offers in order to meet the unreasonable high expectations of biased consumers, which then become partially self-fulfilling. As a result, the presence of biased consumers may improve the welfare of all consumers. We find that an intermediate level of naivete creates the most competition among firms and maximizes consumer welfare.
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