‘A simple model of rank-based decision making (with implications for competition and consumer protection)’
September 24, 2013 Leave a comment
Following on from last week’s excellent external speaker, we welcome two of CCP’s finest in the form of Bob Sugden (ECO, CCP) and Bruce Lyons (ECO, CCP) who are presenting their latest research entitled ‘A simple model of rank-based decision making (with implications for competition and consumer protection)‘. An abstract for their seminar can be found below.
This is a sketch of a model of a market in which most but not all consumers use a rank-based decision rule to choose between products. Various models of rank-based (or ‘relative standing’) decision-making, grounded on assumptions about mental processing, have been proposed by psychologists. They have been offered as explanations of various phenomena in decision-making that appear as anomalous in the perspective of standard decision theory (e.g. asymmetric dominance and the compromise effect). The novel feature of our model (which differentiates it from that of Prelec, Wernerfelt, and Zettelmeyer, 1997) is that consumers observe the market share of each product. We explain why this assumption is plausible. In the model, products are ranked by price (which is readily observable) and quality (which is not). Each rank-choosing consumer has a ‘preferred’ rank by price (e.g. prefers to buy at the 25th percentile of price, defined in terms of market share). Some proportion of consumers act on neoclassical preferences. Under certain assumptions, the model has a unique equilibrium in which the ranking of products by price is the same as the ranking of them by quality, and all consumers act as if they had neoclassical preferences. Thus, all results in the standard theory of oligopoly still apply. On one interpretation, rank-choosing is an efficient heuristic for satisfying ‘true’ preferences when information is limited. On another, it shows how regularities in behaviour at the market level can be induced even if individuals do not have well-articulated preferences.
Rank-choosing consumers are incorporated into the canonical IO model of vertical product differentiation. We examine the conditions which would permit multiple equilibria, in some of which a ‘rogue’ high-price low-quality product may exist with positive market share of only rank-choosing buyers. We identify competitive mechanisms that could eliminate such dominated equilibria and consider the need for consumer protection or the application of competition policy in the presence of this type of behavioural consumer.
The seminar will be taking place in the Thomas Paine Study Centre, Room 1.4 on Friday 27th September.
For further information on the CCP Seminar Series, including a programme of speakers for this semester, visit our website.