Equilibrium Comparison Shopping

Abstract

The most important issue in the legal debates over the form consumer protection legislation should take is whether the state should specify the terms on which consumers may contract or cause the disclosure of information to them. Proponents of disclosure argue that providing information will make markets more competitive. The statutory preamble to the famed Truth in Lending Law ( TIL ) recites: The Congress finds that ... competition among the various financial institutions and other firms engaged in the extension of consumer credit would be strengthened by the informed use of credit . Also, the recent Magnuson-Moss Warranty-Federal Trade Commission Improvement Act provides: In order to ... improve competition in the marketing of consumer products, any warrantor shall ... fully and conspicuously disclose ... the terms and conditions of such warranty . Legal opponents of disclosure argue that consumers will not read the information provided. Several studies of the effectiveness of TIL, summarized in the Report of the National Commission on Consumer Finance, are cited by both sides. Those studies indicate that the number of people unaware of the Annual Percentage Rate paid on credit for recent purchases ranges from almost 90 per cent in poverty areas to 52 per cent in markets populated by relatively affluent buyers. Opponents of disclosure argue that such low awareness levels are inconsistent with the existence of competitive markets. The apparent force of this point is partly responsible for the schizophrenic nature of American consumer protection legislation. The statutes quoted above, despite their paens to disclosure, also regulate the substance of consumer sales contracts. For example, the Magnuson-Moss Act requires the disclosure of warranty terms, but also prohibits sellers in many cases from shifting purchase risks to buyers. Proponents of disclosure regulation, however, argue that the awareness levels reported above will easily yield competitive outcomes. Thus Senator Douglas, the principal legislative supporter of TIL, asserted, unfortunately without explanation, that a competitive market would exist if only 10 per cent of the consumers were cost conscious . The inconclusiveness of this debate seems largely a function of the absence of rigorous analytical tools with which to answer the question how much information is enough. Surprisingly little attention has been devoted to the issue in the economics literature. This paper reflects the beginning of an attempt to resolve it. In particular, it addresses two questions: First, what kinds of equilibria exist when various percentages of consumers are informed? Second, is reducing consumer search costs, the standard technique of modern disclosure legislation, useful in generating competitive equilibria? Both questions are central to the current public policy debate respecting the form which state intervention in consumer markets should take. The equilibrium search models which have been developed in recent years are capable of addressing these questions rigorously. This paper develops one such model which incorporates elements of fixed sample size search. The emphasis on this search strategy