Consumer Inattention & Bill-Shock Regulation

Transcription

1 Consumer Inattention & Bill-Shock Regulation Michael D. Grubb Boston College October 2014

2 Motivation Firms frequently offer consumers contracts with free units and steep penalties for excessive usage Cell phone service: Overages over 20% of US revenues 2003 Checking accounts: 2013 overdraft fees: US $32 Bn & UK 2.9 Bn, Checking accounts: including 0.4 Bn paid item charges. Credit cards

3 Motivation Firms frequently offer consumers contracts with free units and steep penalties for excessive usage Cell phone service: Overages over 20% of US revenues 2003 Checking accounts: 2013 overdraft fees: US $32 Bn & UK 2.9 Bn, Checking accounts: including 0.4 Bn paid item charges. Credit cards Often penalties are a surprise, causing bill shock.

4 Research Question Firms often choose not to disclose whether or not a penalty fee is applicable at the point of sale. Cell phone screen could flash overage rate applies Debit card terminal could ask overdraft applies: continue? yes/no Question: Would it be a good idea to require such disclosure?

5 Recent Regulatory Attention Far too many Americans know what it s like to open up their cell-phone bill and be shocked by hundreds or even thousands of dollars in unexpected fees and charges. But we can put an end to that with a simple step: an alert warning consumers that they re about to hit their limit before fees and charges add up. President Barack Obama, October 17 th, 2011.

6 Recent Regulatory Attention US cellphones: Since 2013, agreement with FCC requires US carriers to alert consumers when they approach and exceed usage allowances (voice, text, data) US Overdraft fees: Effective July 1st, 2010 the Fed requires opt-in for overdraft protection on ATM and debit card transactions. The CFPB wants to do more (proposed penalty fee box ) UK Overdraft fees: In 2011 HMT Consumer Credit and Personal Insolvency Review, major banks agreed to provide optional text/ low balance alerts.

7 Today s Talk Theory Consumer Inattention and Bill-Shock Regulation, Review of Economic Studies 2014 Overconfident Consumers in the Marketplace Draft in preparation for Journal of Economic Perspectives. Applications Cellular Service Demand: Biased Beliefs, Learning, and Bill Shock, with Matthew Osborne American Economic Review forthcoming. Work in progress with Matthew Osborne: low balance alerts for checking accounts.

8 Theory Model (Grubb 2014) 1 Time t = 0: Hotelling duopolists offer contracts & risk neutral consumers choose: P = M + p 1 q 1 + p 2 q 2 + ˆp q 1 q 2 2 Time t {1, 2}: Consumer makes a buy-or-not-buy decision, choosing quantity q t {0, 1} given private value v t F (v). 3 ˆp > 0 penalty fee ˆp < 0 loyalty discount

9 Rational Inattention Between periods 1 & 2, consumer may pay cost k to look up past usage q 1 (to be attentive). If choose to be inattentive: cannot recall q 1 at time 2 cannot condition time 2 purchase on past usage q 1 can only respond to E[MP]

10 Rational Inattention Between periods 1 & 2, consumer may pay cost k to look up past usage q 1 (to be attentive). If choose to be inattentive: cannot recall q 1 at time 2 cannot condition time 2 purchase on past usage q 1 can only respond to E[MP] Sophisticated: anticipates future inattention. Naive: Believes k = 0, so fails to anticipate own inattention.

11 Bill-Shock Regulation(BSR) Bill-Shock Regulation (BSR): Firms must alert consumers at time 2 if ˆp applies.

12 Equivalence Result for Sophisticates Proposition If consumers are sophisticated then inattention and BSR do not affect welfare, profits, consumer surplus, allocations, or market shares.

13 Equivalence Result for Sophisticates Proposition If consumers are sophisticated then inattention and BSR do not affect welfare, profits, consumer surplus, allocations, or market shares. Does not explain why firms charge surprise penalty fees or lobby against bill-shock regulation.

14 Equilibrium with Naive Consumers Naive Result Two possible outcomes: a 1 Firms charge a surprise penalty fee (ˆp > 0) & consumers underestimate chance of paying it 2 Firms offer a surprise loyalty discount (ˆp < 0) & consumers overestimate chance of collecting it In either case, consumers are inattentive & overvalue contracts by k. a Equally profitable but # 1 more robust to arbitrage by attentive consumers. Welfare consequences in Hotelling duopoly? None, because ρ = 1 & ɛ D = 0.

15 Welfare Consequences of Naive Inattention Supply and Demand for Contracts Delivering Un Supply & Demand for Contracts Delivering Utility U n Perceived price decrease True price increase 1 k = contract overvaluation Q Bill Shock Regulation BSR lowers will contract lower contract price by price (1 by: ρ)k 1

16 Consequences depend on pass-through rate & elasticity BSR: price down (1 ρ)k; perceived price up ρk BSR Benefits: ɛ D = 0 ɛ D < 0 ρ = 1 no one marginal cons. ρ = 0 infra-marginal cons.

17 Consequences depend on pass-through rate & elasticity BSR: price down (1 ρ)k; perceived price up ρk BSR Benefits: ɛ D = 0 ɛ D < 0 ρ = 1 no one marginal cons. ρ = 0 infra-marginal cons. Overdraft fees: Jamie Dimon, CEO of JPMorgan Chase says ρ = 1: If you re a restaurant and you can t charge for the soda, you re going to charge more for the burger. Over time, it will all be repriced into the business.

18 Consequences depend on pass-through rate & elasticity BSR: price down (1 ρ)k; perceived price up ρk BSR Benefits: ɛ D = 0 ɛ D < 0 ρ = 1 no one marginal cons. ρ = 0 infra-marginal cons. Overdraft fees: Jamie Dimon, CEO of JPMorgan Chase says ρ = 1: If you re a restaurant and you can t charge for the soda, you re going to charge more for the burger. Over time, it will all be repriced into the business. Credit cards: Agarwal, Chomsisengphet, Mahoney, & Stroebel (forthcoming) argue ρ 0 given Ausubel (1999) and their estimate that 2009 CARD act fee reductions save consumers $13Bn/yr.

19 Consequences depend on pass-through rate & elasticity BSR: price down (1 ρ)k; perceived price up ρk BSR Benefits: ɛ D = 0 ɛ D < 0 ρ = 1 no one marginal cons. ρ = 0 infra-marginal cons. Overdraft fees: Jamie Dimon, CEO of JPMorgan Chase says ρ = 1: If you re a restaurant and you can t charge for the soda, you re going to charge more for the burger. Over time, it will all be repriced into the business. Credit cards: Agarwal, Chomsisengphet, Mahoney, & Stroebel (forthcoming) argue ρ 0 given Ausubel (1999) and their estimate that 2009 CARD act fee reductions save consumers $13Bn/yr. Cellphone service: Genakos & Valletti (2011) find ρ < 1 but close to 1 in EU. Grubb & Osborne (forthcoming) est. ρ 1 in US.

20 Mix of Attentive & Naively Inattentive Proposition Bill-shock regulation ends cross-subsidies, helping the naive at the expense of the attentive.

21 Price Discrimination Between Sophisticates Suppose that All consumers are sophisticated Ex ante there are types with low (v t F L ) and high (v t F H ) demand Firms want to price discriminate Surprise penalty fees are a tool for price discrimination they can relax incentive constraints without distorting allocations

22 Price Discrimination Between Sophisticates Suppose that All consumers are sophisticated Ex ante there are types with low (v t F L ) and high (v t F H ) demand Firms want to price discriminate Surprise penalty fees are a tool for price discrimination they can relax incentive constraints without distorting allocations Proposition In fairly competitive markets: BSR strictly decreases welfare. Firms and low types are losers but high types are winners.

23 Price Discrimination Between Sophisticates Suppose that All consumers are sophisticated Ex ante there are types with low (v t F L ) and high (v t F H ) demand Firms want to price discriminate Surprise penalty fees are a tool for price discrimination they can relax incentive constraints without distorting allocations Proposition In fairly competitive markets: BSR strictly decreases welfare. Firms and low types are losers but high types are winners. Intuition: Firms discriminate less & substitute to quantity distortions lower markup on contract H lower allocation & raise markup on contract L

24 Theory Summary Consequences of Bill-shock regulation depend on Consumer sophistication or naivete Consumer heterogeneity Market pass-through rate Elasticity of demand

25 Application: FCC Bill-Shock Agreement Source: Grubb & Osborne (Forthcoming) Question: Will the FCC Bill-Shock Agreement help or hurt consumers? Timing: Asked before agreement implemented. Can we predict the policy s affect?

26 Application: FCC Bill-Shock Agreement Source: Grubb & Osborne (Forthcoming) Question: Will the FCC Bill-Shock Agreement help or hurt consumers? Timing: Asked before agreement implemented. Can we predict the policy s affect? Data: Panel of 15,000 student bills Exercise: Estimate demand & Simulate policy

27 5 Stylized Facts & Modeling Approach Consumers are (1) price sensitive, (2) uncertain about the ex post marginal price, and (3) inattentive. bill-shock alerts affect choice model inattentive (but sophisticated) consumption

28 5 Stylized Facts & Modeling Approach Consumers are (1) price sensitive, (2) uncertain about the ex post marginal price, and (3) inattentive. bill-shock alerts affect choice model inattentive (but sophisticated) consumption Consumers (4) learn and switch plans but also (5) make predictable mistakes We allow for biased beliefs: Identify true distribution of tastes (from usage patterns) Identify prior beliefs (from plan choices) Biases measure systematic differences between the two, and lead to predictable mistakes

29 Results Overconfidence: underestimate uncertainty about usage by 62% Bill shock regulation prices fixed: avg. annual consumer welfare rises $103 but prices vary: firms lower overage rates & adjust monthly fees and allowances to offset lost overage revenue avg. annual consumer welfare falls $33

30 Results Overconfidence: underestimate uncertainty about usage by 62% Bill shock regulation prices fixed: avg. annual consumer welfare rises $103 but prices vary: firms lower overage rates & adjust monthly fees and allowances to offset lost overage revenue avg. annual consumer welfare falls $33

31 Results Overconfidence: underestimate uncertainty about usage by 62% Bill shock regulation prices fixed: avg. annual consumer welfare rises $103 but prices vary: firms lower overage rates & adjust monthly fees and allowances to offset lost overage revenue avg. annual consumer welfare falls $33 Density Density Unregulated Bill Shock Reg Annual Utility Change from Bill Shock Monthly Overage Fee ($)

32 Conclusion Bill-shock regulation may help or hurt consumers FCC s bill-shock agreement may be a nudge that back-fires and harms consumers (a little). Similar regulation for overdraft fees is more promising Banks price discriminate, but do not vary overdraft charges across accounts to do so. US opt-in rates are suggestive of naivete. evidence for heterogeneous attention. pass-through rate likely to be low

33 Conclusion Bill-shock regulation may help or hurt consumers FCC s bill-shock agreement may be a nudge that back-fires and harms consumers (a little). Similar regulation for overdraft fees is more promising Banks price discriminate, but do not vary overdraft charges across accounts to do so. US opt-in rates are suggestive of naivete. evidence for heterogeneous attention. pass-through rate likely to be low Other applications: Frequent flyer perks, electricity, healthcare,...