Consumers and behavioral IO Prof Colin CamererBehavioral IO Prof Colin CamererFirms: Limits on firm rationalityLimits on firm rationalityExps 1-4 typical recruiting, exps 5-8 self selection for skillε-equilibrium and pricing: Small ε can have large IO effectsBertrand price matching with loyalty rewards (Capra, Goeree, Gomez, Holt AER ‘99)Example: Price matching with loyalty rewards (Capra, Goeree, Gomez, Holt AER ‘99)QRE for various RCognitive hierarchy model (Camerer, Ho, Chong QJE 04)Price matching data over timeSlide 12Slide 13Influence of low (79) and high advice (119) with R=5 (Cabrera-Capra-Gomez 04)B. Consumers are limitedly rational, firms anticipate or respond1. Rules of thumb3. Pricing procrastinatorsPricing virtuous goods: Gyms IGyms IIGyms III4. Why hasn’t internet created price wars? Obfuscation & hidden fees (G+S Ellison2 04)Hidden “shrouded” add-ons (Gabaix-Laibson QJE 06)Hidden add-ons IIHidden add-ons: Why doesn’t competition work?5. Loss-aversion & pricing (Heidhues & Koszegi, 04)Loss-aversion results6. LearningPeople learn in 3-4 yrsLearning and forgetting (reinforcement)Phone calling plans7. RegulationMy (our) viewSlide 33Central empirical questionsCrowding out of consumer vigilanceFTC concernsConclusion: Behavioral IOWhere do behavioral IO assumptions come from?Open questions01/15/19 1Consumers and behavioral IOConsumers and behavioral IOProf Colin CamererProf Colin CamererWhat happens in industrial structure and What happens in industrial structure and consumer choice if agents are limited in consumer choice if agents are limited in rationality or willpower? rationality or willpower? Ellison (07): Ellison (07): A. Firms are limitedly rational A. Firms are limitedly rational B. Consumers are limitedly rational, firms B. Consumers are limitedly rational, firms respondrespondC. Scope for regulation? (e.g. consumer C. Scope for regulation? (e.g. consumer protection)protection)Evidence from household finance, etc. Evidence from household finance, etc.01/15/19 2Behavioral IOBehavioral IOProf Colin CamererProf Colin CamererFirms are limitedly rational Firms are limitedly rational Cyert and March 56Cyert and March 56Business entry (Camerer-Lovallo 99)Business entry (Camerer-Lovallo 99)Corporate finance (e.g. overconfident CEO’s Corporate finance (e.g. overconfident CEO’s Malmendier, mergers)Malmendier, mergers)εε-equilibrium in Cournot, Bertrand competition-equilibrium in Cournot, Bertrand competitionFairness and learning in price matching experimentsFairness and learning in price matching experiments01/15/19 3FirmsFirms: Limits on firm rationality: Limits on firm rationalityBehavioral theories of the firm (50s)Behavioral theories of the firm (50s)Largely died out. Why? Largely died out. Why? Did not have agency theory etc. to work withDid not have agency theory etc. to work withWhy wouldn’t bad managers be replaced?Why wouldn’t bad managers be replaced?Poor sparse dataPoor sparse dataWhat is an “organizational routine”? What is an “organizational routine”? Due for revisit? Due for revisit? ““routines” of organizations are cognitive, correlating routines” of organizations are cognitive, correlating devices (Kreps 90)devices (Kreps 90)Does appear that firms get stuck repeating success of Does appear that firms get stuck repeating success of the past, have trouble changing (e.g. GM, Sears)the past, have trouble changing (e.g. GM, Sears)Poor governance can explain non-profit-max’nPoor governance can explain non-profit-max’nBetter data Better data01/15/19 4Limits on firm rationalityLimits on firm rationalityManagerial overconfidenceManagerial overconfidenceHigh rate of business failure. Why?High rate of business failure. Why?Business entry experiments (Cam-Lovallo 99)Business entry experiments (Cam-Lovallo 99)Top c+5 entrants share $50. Others get -$10Top c+5 entrants share $50. Others get -$10Ranked by random numbers or skill (trivia)Ranked by random numbers or skill (trivia)01/15/19 5Exps 1-4 typical recruiting, Exps 1-4 typical recruiting, exps 5-8 self selection for skill exps 5-8 self selection for skill01/15/19 6εε-equilibrium and pricing: -equilibrium and pricing: Small Small εε can have large IO effects can have large IO effectsεε-equilibrium, approximate best responses-equilibrium, approximate best responsesBertrand duopoly: Set prices, consumer buys cheapestBertrand duopoly: Set prices, consumer buys cheapest both sellers price at marginal costboth sellers price at marginal costBut there areBut there are mixed mixed εε-equilibrium -equilibrium (Baye-Morgan 04 RAND)(Baye-Morgan 04 RAND)Can earn (2Can earn (2εεππmm))1/21/2--εε from deviating (p>cost) from deviating (p>cost)e.g. if e.g. if εε=.01=.01ππmm industry profit is .26 industry profit is .26ππmm  mild deviations produce strong pressure away from perfect mild deviations produce strong pressure away from perfect competitioncompetitionCournot quantity competition, D(p)=1-pCournot quantity competition, D(p)=1-pQuantities in range (1/3)Quantities in range (1/3)±(2/3)±(2/3)((εε))1/2 1/2 are are εε-equil. (q=1/3 is comp.)-equil. (q=1/3 is comp.)Includes monopoly (q=1/4 each) for Includes monopoly (q=1/4 each) for εε>1/64>1/6401/15/19 7Bertrand price matching with loyalty Bertrand price matching with loyalty rewards rewards (Capra, Goeree, Gomez, Holt AER ‘99)(Capra, Goeree, Gomez, Holt AER ‘99)Players 1, 2 pick integer prices Players 1, 2 pick integer prices [80,200] ¢[80,200] ¢Price is P=min(PPrice is P=min(P1,1,,P,P22))Low price firm earns P+R (R>1)Low price firm earns P+R (R>1)High price firm earns P-RHigh price firm earns P-RWhat happens?What happens?01/15/19 8Example: Price matching with loyalty Example: Price matching with loyalty rewards rewards (Capra, Goeree, Gomez, Holt AER ‘99)(Capra, Goeree, Gomez, Holt AER ‘99)Players 1, 2 pick prices [80,200] ¢Players 1, 2 pick prices [80,200] ¢Price is P=min(PPrice is P=min(P1,1,,P,P22))Low price firm earns P+RLow price firm earns P+RHigh price firm earns P-RHigh price firm earns P-RWhat happens?What happens?Rational theory: competition Rational theory: competition  prices go prices go to 80to 80Always want to undercut by 1 unitAlways want to undercut by 1 unit01/15/19 9QRE for various RQRE for various