Shrouded Attributes and Information Suppression in Competitive Markets

Following Becker (1957) we ask whether competition will eliminate the effects of behavioral biases. We study the case of shrouded product attributes, such as maintenance costs, expensive add-ons, and hidden fees. In standard competitive models with costless advertising all firms choose to reveal all product information. We show that information revelation breaks down when some naive consumers do not anticipate shrouded attributes. Firms will not compete by publicly undercutting their competitors’ add-on prices if (i) add-ons have close substitutes that are only exploited by sophisticated consumers, or (ii) many consumers drop out of the market altogether when the add-on market is made salient. We show that informational shrouding flourishes even in highly competitive markets, even in markets with costless advertising and ∗For useful suggestions we thank Daron Acemoglu, Simon Anderson, Mark Armstrong, Ian Ayres, Douglas Bernheim, Andrew Caplin, Kenneth Corts, Avinash Dixit, Glenn Ellison, Drew Fudenberg, Edward Glaeser, Joseph Farrell, Robert Hall, Sergei Izmalkov, Paul Klemperer, Julie Mortimer, Barry Nalebuff, Aviv Nevo, Ariel Pakes, Nancy Rose, Jose Scheinkman, Andrei Shleifer, Chad Syverson, David Thesmar, and seminar participants at Berkeley, Columbia, Harvard, MIT, NBER, New York University, Princeton, Stanford, the University of Virginia, the 2003 European Econometric Society meeting, and the 2004 American Economic Association meeting. Carlos Caro, Steve Joyce and Laura Serban provided great research assistance. We acknowledge financial support from the NSF (SES-0099025). Gabaix thanks the Russell Sage Foundation for their hospitality during the year 2002-3. Xavier Gabaix: MIT, 50 Memorial Drive, Cambridge, MA 02142, xgabaix@mit.edu. David Laibson: Harvard University, Department of Economics, Cambridge, MA, 02138, dlaibson@arrow.fas.harvard.edu.