Privacy in Competitive Markets

Abstract

Personal privacy is studied in the context of a competitive product (or labor) market. In the first stage of the game, firms that sell homogeneous goods or services (e.g., insurance, credit, or rental housing) post prices they promise to charge approved applicants. In the second stage, each consumer chooses whether to apply to one of the firms. Next, the firms acquire information about their applicants and sell the good to the ones they approve. Contracts are incomplete in the sense that the amount of information firms acquire cannot be observed. In the unique subgame perfect equilibrium outcome, firms post the lowest price consistent with zero economic profit. Unfortunately, this low price gives them incentives to acquire excessive amounts of information about their applicants. It is shown that this inefficient infringement of privacy is exacerbated if firms have the opportunity to sell customer information. Also, in an effort to preserve privacy, consumers typically demand inefficiently low levels of output. Finally, it is shown that if rejected consumers can continue to apply for the good at different firms, then the resulting adverse election may seriously undermine the market and generate a situation in which all parties would be better off if no information was collected at all.