The Non-Shopper Problem
In a few high-profile markets, prices seem to stay far above average cost even though there are tons of competitors. There are thousands of credit card issuers, but the average interest rate is 18.26%. There are over 100,000 real estate brokerage firms, but the default commission remains 6%. Sure, unsecured credit has a high default risk, but high enough to justify an 18.26% rate? And why on Earth would it cost $60,000 to sell a million-dollar home?
From the standpoint of economic theory, such industries are deeply puzzling. In monopoly models, prices stay above average cost forever, but calling an industry with thousands of competitors a “monopoly” seems absurd. In oligopoly and monopolistic competition models, prices stay above marginal cost forever, but entry should still drive prices down to average costs.
My UT friends John Hatfield and Richard Lowery (plus Scott Kominers) have a model where realtors are basically a giant cartel that crushes price competition with the threat of ferocious retaliation. (More elaboration here and here). The HKL math is impressive, but ultimately it’s an incredible conspiracy theory. What evidence is there that realtors really are unleashing hell on price-cutters? I see cut-rate realtors in my neighborhood all the time. And the same is even clearer for credit cards. Zero-interest offers show up in my mailbox on a regular basis.
What’s really going on? I propose a much simpler model than HKL. Namely: In some industries, many consumers foolishly fail to shop around. Maybe they’re lazy. Maybe they’re fatalistic. Maybe they don’t want to look cheap. Maybe they don’t want to look weird. Whatever the non-shoppers’ motivation, however, the result is the same. If firms know that many consumers don’t shop around, then one profit-maximizing business model is simply to charge a high price and see how many suckers come along.
Sure, rival firms will compete for the price-sensitive consumers. Or maybe each firm will charge an easy-to-see high price for suckers and a (slightly) harder-to-see low price for bargain-hunters. Either way, however, we’ll see a long-run equilibrium where a lot of people pay prices that far exceed average cost. Indefinitely.
Why is my model better than HKL? Because it explains the same facts – lots of firms persistently charging above average cost – without straining credulity.
Look around with your own eyes. Don’t you see lots of people who stubbornly fail to shop around, even though shopping around totally works? I sure do. For virtually any major purchase, I ask the vendor, “Can you do any better?” And guess what? They cut my price two-thirds of the time. Everyone else pays full price.
The same goes for realtors. Discount realtors advertise publicly. And several of my friends have negotiated commission cuts with “full-price” firms. A little self-advocacy can easily yield $10k in savings. For credit cards, I know grad students who did 0% balance transfers over and over, receiving many thousands of dollars of unsecured credit for negative real interest rates despite their very low income. All fueled by the power of gumption and frugality.
As a classic Payless commercial from the 80s remarks, “You could pay more, but why?”
Should we deem this situation a “market failure“? Only if you hold markets to impossibly high standards. If consumers pay high prices because they refuse to shop around, many businesses will naturally charge high prices. But in such scenarios, it makes far more sense to say that it is not the market, but the consumers, who have failed.
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Yes, this is a market failure. It produces all the wrong incentives. On the part of the seller to find suckers and on the part of the buyers it sorts according to ability/willingness/capacity to shop around, a dubious axis to sort by. For stock markets, the solution comes through regulation NBBO price (National Best Bid and Offer). Or does it sound like a good policy to let each stock market charge a different price for APPL for consumers who don't shop around (think Robinhood not HFT). In fact, this is exactly where regulation might help.
I suspect that for a lot of people it's about the "noise". That as the people's "life feed" just gets louder and more awash in all forms of contradictory information they shut down and all forms of new information have a much harder time getting in. People's overwhelm thresholds are just constantly being tested. This feeling that that they'll never be able to do a satisfactory job of shopping, or research, or vetting results in a kind of surrender to the readily at hand, the comfortable. It's living mentally on the other side of "the paradox of choice" full time. Sure, I see the better deal, but is it really? I really should read that fine print to see if I'm getting suckered (again), I really should spreadsheet all the myriad options, I really should check to see if all these review sites are just shill sites. Oh no, another related side quest rabbit hole. Oh no, why has my inbox and social media feed and all the surfing targeted ads now started blasting me with even more stuff I've been researching? Uncle, UNCLE!
I feel like they understand this in politics the last few decades. Just rain a holy hell of info (and dis-info) down on their heads and they'll grasp the hands of the few they know and trust even if they're pretty clearly the worse choice. The any port in the storm theory I guess. Just crank up the storm and people make poor choices.