Abstract: Firms signal their quality through prices. But are all consumers able to interpret these signals? There are some naive consumers present in the market who cannot judge the quality of the product through prices because of cognitive limitations. In a static signaling model, I analyze the pricing behavior of a monopolist, selling product of uncertain quality, in the presence of such naive consumers. In the high-quality state, the presence of high proportion of naive consumers reduces the price of the product and hence improves overall welfare of the society. On the other hand, in the low-quality state, it increases the price of the product (depending on the valuations) thereby reducing social surplus. Allowing for disclosure as an alternative to communicate quality, the high-quality monopolist has no incentive to disclose in the presence of high proportion of naive consumers. This provides partial explanation for the infrequent voluntary disclosure by some industries.
Abstract: In markets where buyers have incomplete information about product quality, consumer sophistication increases the case for strong regulation of deceptive advertising by firms. In a model where a fraction of buyers are naive (i.e., cannot update beliefs based on market signals and believe all advertising claims), I show that the socially optimal level of penalty is (a) higher than the penalty required to merely avoid deception by firms and (b) increasing in the proportion of sophisticated buyers. The optimal penalty for false advertising not only discourages deception but also reduces prices by eliminating signaling distortion. Moreover, low-level of penalty is worse than zero penalty from a welfare standpoint.
Work in Progress
Regulation of Native Advertising
Abstract: Recent FTC regulations require a mandatory disclosure of paid advertising content. This is in response to the emerging phenomenon of native advertising, wherein firms advertise their products through influencers (social media posts and editorial content) without disclosing that it is a paid advertisement. Such eWoM has been empirically found to be informative as well as persuasive, leading to positive impact on sales. However, consumers make purchase decisions unaware of the fact that the content is sponsored, which is deceptive in the eyes of law. Moreover, several cases of false product claims through native advertisements have emerged. Therefore, the FTC has stepped in to protect the consumers by mandating a conspicuous disclosure of any connection between influencers and advertisers. This paper investigates the impact of FTC's disclosure policy on (i) firm's and influencer's strategies, (ii) consumers' beliefs and (iii) social welfare. I show that the impact of disclosure policy is twofold — it prevents the possibility of sending out false product claims to a significant extent as well as improves the quality of information for the buyers to make better purchase decisions.