Excessive Competition for Headline Prices

Abstract

When firms’ shrouding of charges, as in Gabaix and Laibson (2006), meets with consumers’ salient thinking, as in Bordalo et al. (2013), this can have severe welfare implications. The ensuing excessive competition for headline prices tends to inefficiently bias consumers’ choice towards low-quality products, which is compounded when firms react and reduce quality beyond what would be cost efficient. As more intense shopping leads to a greater “pass through” of shrouded charges into lower headline prices, which aggravates the problem, competition policy is no substitute for consumer protection policy. While in our model all consumers are potential victims of salient thinking and shrouded charges, salient thinking becomes effective only for those who are attentive to different offers. Attentive consumers are likely to show ex-post regret and they can be ex-ante worse off, even though their choice set is larger. The combination of shrouding and salient thinking can sufficiently disadvantage high-quality firms so as to make them willing to educate consumers and unshroud all charges. While there is no unshrouding on equilibrium, high-quality firms’ threat of unshrouding may sufficiently discipline firms to make efficient product choices.