Exploiting naiveté: On the interaction of boundedly rational agents with sophisticated ones
Final Report Abstract
How do humans make decisions in complicated situations? What determines their choices and what shortcomings do these exhibit? In this research project I wanted to examine the way in which the answers to these questions affect outcomes, when naive agents interact with others in complex strategic environments. In particular, I wanted to address, in three subprojects, how sophisticated agents exploit naive ones and how naive agents can be protected. In a first project, we examined how naive agents are exploited by firms with deceptive products in markets with search frictions. We showed that in search markets stronger competition in the form of smaller search frictions may not weaken but strengthen firms’ incentives to engage in exploitative behavior. As a consequence, it may be the case that naive consumers who are susceptible to deception lose out when search frictions fall. When deceptive products are very inefficient, reducing search frictions may even reduce total welfare. We also identified a novel channel through which deception harms sophisticated consumers: they waste time examining irrelevant inferior products. These findings qualify the conventional wisdom about the beneficial effects of policy measures that reduce search frictions such as the harmonization of price or product formats. Interventions that improve consumer and overall welfare in our setting are minimum quality standards and transparency policies that seek to educate naive consumers. In a second project, I developed a model of self-similarity heuristics (strategy-projection) equilibrium which captures the agent’s inability to take the point of view of others. I showed that in super-modular (sub-modular) games agents choose more extreme (similar) options in a strategy-projection equilibrium than in a Nash-equilibrium. However, for a wide class of games, strategy-projection equilibrium is behaviorally indistinguishable from taste-projection equilibrium.
