Unrealistic Beliefs in Search Markets

Tobit Gamp (Humboldt University Berlin)

November 16, 2020, 14:00–15:30

Room Zoom

Industrial Organization seminar


We study a search market in the spirit of Diamond (1971) in which some (naive) consumers have biased beliefs about what the market supplies which only partially reflect the true market conditions. Specifically, a belief function specifies for any (true) distribution of utility offers in the market a possibly incorrect distribution of utility offers upon which naive consumers base their search strategy. We characterize the properties of the belief function which determine the equilibrium outcome. We show that if and only if the belief function is non-pessimistic, a novel type of equilibrium may emerge in which firms offer penny sales in order to meet the unreasonable high expectations of naive consumers, which then become partially self-fulfilling. We show that the presence of naive consumers may improve the welfare of all consumers in the market, as they engage in excessive search which enhances competition and benefits all consumers. Interestingly, an intermediate level of naivete creates the most competition and maximizes the welfare of naive and standard consumers. (joint with Daniel Krähmer).