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Grounded in key observations in consumer psychology, Bounded Rationality and Industrial Organization develops non-standard models of "boundedly rational" consumer behavior and embeds them into familiar models of markets.

Conventional economic theory assumes that consumers are fully rational, that they have well-defined preferences and easily understand the market environment. Yet, in fact, consumers may have inconsistent, context-dependent preferences, or simply not enough brain-power to evaluate and compare complicated products. Thus the standard model of consumer behavior-which depends on an ideal market in which consumers are boundlessly rational?is called into question. While behavioral economists have for some time confirmed and characterized these inconsistencies, the logical next step is to examine the implications they have in markets. Grounded in key observations in consumer psychology, Bounded Rationality and Industrial Organization develops non-standard models of "boundedly rational" consumer behavior and embeds them into familiar models of markets. It then rigorously analyses each model in the tradition of microeconomic theory, leading to a richer, more realistic picture of consumer behavior. Ran Spiegler analyses phenomena such as exploitative price plans in the credit market, complexity of financial products and other obfuscation practices, consumer antagonism to unexpected price increases, and the role of default options in consumer decision making. Spiegler unifies the relevant literature into three main strands: limited ability to anticipate and control future choices, limited ability to understand complex market environments, and sensitivity to reference points. Although the challenge of enriching the psychology of decision makers in economic models has been at the frontier of theoretical research in the last decade, there has been no graduate-level, theory-oriented textbook to cover developments in the last 10-15 years. Thus, Bounded Rationality and Industrial Organization offers a welcome and crucial new understanding of market behavior-it challenges conventional wisdom in ways that are interesting and economically significant, and which in the end effect the well-being of all market participants.

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Preface		ix
1	Introduction		1
1.1	Bibliographic Notes		7
Part 1	Anticipating Future Preferences		
2	Dynamically Inconsistent Preferences I: Unconstrained Contracting		11
2.1	The Multi-Selves Model		12
2.1.1	Naivete		13
2.2	Monopoly Pricing		14
2.2.1	Optimal Price Schemes for Sophisticated Consumers		15
2.2.2	Optimal Price Schemes for Naive Consumers		15
2.2.3	Screening the Consumer''s Type		18
2.3	Competitive Pricing		18
2.4	Welfare Analysis		20
2.5	Educating Naive Consumers		21
2.6	The Interpretation of Naivete		22
2.7	Two Applications		23
2.8	Other Topics		25
2.8.1	The (?, ?) Model		25
2.8.2	Preference Heterogeneity		26
2.9	Summary		28
2.10	Bibliographic Notes		28
3	Dynamically Inconsistent Preferences II: Constrained Contracting		30
3.1	Two-Part Tariffs		30
3.1.1	Departure from Marginal-Cost Pricing		31
3.1.2	Welfare Analysis		33
3.2	Destabilization of Commitment Devices: Renegotiation and Spot Market Competition		34
3.3	Self-Control		36
3.3.1	Implications for Monopoly Pricing		39
3.3.2	Do Self-Control Costs Hamper Competition?		40
3.4	Summary		41
3.5	Bibliographic Notes		42
4	Dynamically Inconsistent Preferences III: Partial Naivete		43
4.1	Magnitude Naivete		43
4.1.1	Monopoly Pricing		43
4.1.2	Are More Sophisticated Consumers Always Better Off?		45
4.2	Frequency Naivete		46
4.2.1	First-Best Monopoly Pricing		47
4.2.2	Second-Best Monopoly Pricing		48
4.2.3	Does Competition Curb Exploitation?		51
4.3	Summary		52
4.4	Bibliographic Notes		52
5	Biased Beliefs without Dynamic Inconsistency		53
5.1	Monopoly Pricing with Over-Optimistic Consumers		54
5.1.1	Comparison with Related Models		57
5.2	Overconfidence: Three-Part Tariffs		60
5.3	Unforeseen Contingencies: Add-On Pricing		62
5.4	A Summary Exercise: Insurance Markets with Biased Consumers		67
5.4.1	Equilibrium Analysis When Subjective Beliefs Are Observable		69
5.4.2	Equilibrium Analysis When Subjective Beliefs Are Private Information		70
5.5	Summary		73
5.6	Bibliographic Notes		73
Part 2	Responding to Market Complexity		
6	Sampling-Based Reasoning I: Price Competition and Product Differentiation		77
6.1	A Sampling-Based Choice Procedure		77
6.2	Price Competition and Technology Adoption		78
6.2.1	Nash Equilibrium		80
6.2.2	Welfare Analysis		82
6.3	Spurious Product Differentiation		84
6.3.1	Nash Equilibrium		85
6.3.2	Product Complexity as a Differentiation Device		86
6.4	Can the Market Educate Consumers?		90
6.5	Summary		92
6.6	Bibliographic Notes		92
7	Sampling-Based Reasoning II: Obfuscation		94
7.1	A Model of Competitive Obfuscation		94
7.1.1	Nash Equilibrium		96
7.1.2	Welfare Analysis		100
7.2	Production Inefficiencies		100
7.3	Multi-Dimensional Prices		103
7.4	A Market Intervention: Introducing "Simple" Options		104
7.5	Summary		107
7.6	Bibliographic Notes		108
8	Coarse Reasoning		110
8.1	A Modeling Framework		110
8.2	Complex Price Patterns as a Discrimination Device		112
8.2.1	"DeBruijn" Price Sequences		114
8.2.2	Conditions for Profitability of Complex Price Patterns		115
8.3	Limited Understanding of Adverse Selection		118
8.3.1	A Buyer-Seller Example		119
8.3.2	A Benchmark: A Bayesian-Rational Buyer		120
8.3.3	A "Coarse" Buyer		120
8.3.4	Action-Dependent Feedback		122
8.4	Summary		123
8.5	Bibliographic Notes		124
Part 3	Reference Dependence		
9	Loss Aversion		127
9.1	Expected Price as a Reference Point: Monopoly Pricing		128
9.1.1	Reduced Price Variability		130
9.1.2	Impact on Average Prices		134
9.2	Price Uniformity in a Duopoly Setting "Kinked" Demand		135
9.3	Expected Consumption as a Reference Point: An "Attachment Effect"		138
9.3.1	Personal Equilibrium		139
9.3.2	Price Randomization		141
9.4	Discussion		143
9.4.1	Actual Prices as Reference Points		143
9.4.2	Pleasant Surprises		144
9.5	Summary		145
9.6	Bibliographic Notes		146
10	Inertia I: Price Competition		147
10.1	Price Competition under Consumer Inertia		148
10.2	Price-Frame Competition		151
10.2.1	Nash Equilibrium		153
10.2.2	Equilibrium Properties		157
10.2.3	Two Market Interventions		158
10.3	Consumer Switching		159
10.4	Asymmetric Default Assignment		160
10.5	A Few General Remarks		161
10.5.1	More Than Two Frames		161
10.5.2	Revealed Preferences		163
10.6	Summary		163
10.7	Bibliographic Notes		164
11	Inertia II: Costly Marketing		166
11.1	A Model of Competitive Marketing		167
11.2	Nash Equilibrium		170
11.3	The Effective Marketing Property		176
11.4	Discussion		178
11.5	Summary		180
11.6	Bibliographic Notes		180
Part 4	Discussion		
12	Recurring Themes		183
12.1	Complex Pricing Strategies		183
12.2	Spurious Variety		184
12.3	Market Transactions as a Form of Speculative Trade		185
12.4	How Effective Are Competition and Consumer Protection Policies?		186
12.5	Externalities between Rational and Boundedly Rational Consumers		187
12.6	Conclusion		187
13	But Can''t We Get the Same Thing with a Standard Model?		188
13.1	Rationalization via Modified Information		190
13.2	Rationalization via Modified Preferences		194
13.3	Rationalization via Endogenization		196
13.4	Discussion		199
13.5	Epilogue		200
13.6	Bibliographic Notes		201
A	Appendix to Part I: A Decision-Theoretic Perspective		202
A.1	The Multi-Selves Model		202
A.2	Self-Control Preferences		204
A.3	The Relation between Self-Control Preferences and the Multi-Selves Model		208
A.4	Other Classes of Temptation-Driven Preferences		210
A.5	Bibliographic Notes		211
Bibliography		213
Index		219