Rev Ind Organ (2015) 47:243–245 DOI 10.1007/s11151-015-9475-y
Introduction: Behavioral Industrial Organization Michael D. Grubb1 • Victor J. Tremblay2
Published online: 9 September 2015 Ó Springer Science+Business Media New York 2015
The ‘‘standard’’ model in economics assumes fully rational consumers, input suppliers, and producers. Preferences are stable and defined over a narrow set of outcomes such as quality and quantity consumed, price paid, and risk borne. Other aspects of the environment such as reference points, default options, framing, and ambiguity are omitted. If present, asymmetric information stems from a common prior, and uninformed parties have both rational expectations and the strategic sophistication to make correct inferences from other players’ actions. As the evidence began to show that these assumptions are not always valid, new models were developed, and behavioral economics was born. Behavioral economics uses evidence from psychology and experimental economics to enrich our understanding of decision making. Although economists have long recognized psychological concepts (see Rabin 1998; Angner and Loewenstein 2012 for reviews of the literature), formal analysis began with Simon’s 1955 development of the concept of bounded rationality. Since then, relaxing the assumption of full rationality and standard assumptions on preferences has led to new theoretical models and new insights across many fields of economics and finance. Our field is no exception, and in the last 15 years there has been a surge of interest in improving our models in industrial organization with contributions from
& Michael D. Grubb
[email protected] Victor J. Tremblay
[email protected] 1
Economics Department, Boston College, 140 Commonwealth Avenue, Maloney Hall 341, Chestnut Hill, MA 02467, USA
2
Department of Economics, Oregon State University, 303 Ballard Extension Hall, Corvallis, OR 97330, USA
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behavioral economics, which has been stimulating the development of behavioral industrial organization (Ellison 2006; Spiegler 2011; Tremblay and Tremblay 2012). The authors in this series are leaders in the field of behavioral industrial organization. Their papers show how behavioral concepts have helped shape research in behavioral industrial organization. The papers are ordered for readers who are unfamiliar with behavioral industrial organization. General survey papers come first, followed by papers that are primarily theoretical, empirical, and policy related. The first paper by Grubb (2015a) surveys the industrial organization literature with behavioral consumers. He focuses on three issues: (1) how the presence of nonstandard preferences affect firm behavior; (2) how overconfidence and other biases lead to contracts that take advantage of these mistakes; and (3) how spurious product differentiation and market power can arise when consumers fail to choose the best price. In the second paper, Eliaz and Spiegler (2015) discuss three theoretical directions in which they have been working to expand the methodological scope of behavioral industrial organization: First, they discuss how combining data on firm marketing messages and consumer switching with the assumption that firms play a Nash equilibrium could in principle be used to infer consumers’ unobserved consideration sets. Next, they discuss recent work that connects behavioral industrial organization more closely to choice theory. Finally, they discuss ways in which behavioral industrial organization models can be integrated into larger models of the economy. The third paper by Armstrong (2015) surveys models of markets where not all consumers are savvy (i.e., experienced and well informed). This paper addresses two questions: First, when do savvy consumers exert a search externality on nonsavvy consumers, protecting them from unreasonable market outcomes, and when do savvy consumers exert a ripoff externality on non-savvy consumers, collecting cross-subsidies from them? Second, in each setting, what policies benefit both types of consumers and what policies protect one group at the expense of the other? The fourth paper by Grubb (2015b) discusses the theory, evidence, and policy implications in markets with consumers who fail to choose the best price from sellers of an objectively homogeneous good. Such failures may arise when consumers search too little, are confused when comparing complex prices, or exhibit excessive inertia and switch too little. In markets such as these, theory and evidence show that market power may persist even with large numbers of sellers. The survey draws connections between market models that embed one or more of these consumer mistakes and field evidence from real markets. Finally, policy implications are also discussed. In the fifth paper, Heidhues and K}oszegi (2015) show how equilibrium contracting in markets with naı¨ve consumers can lead to substantial overparticipation by naı¨ve consumers and large social welfare losses as a result. They use a calibration technique to estimate the size of this inefficiency in the U.S. market for credit cards. They estimate that many credit-card borrowers would be better off without credit cards altogether, and that the total welfare loss from their participation in the market is significant, amounting to approximately $300 per U.S. household. This suggests that market intervention is in order.
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In the final paper, Bailey (2015) shows how behavioral economics can contribute to antitrust policy. She shows that a failure to incorporate behavioral issues into our models can lead to incorrect antitrust-policy outcomes. She uses four case studies to illustrate this point: (1) the price fixing case that involved Ivy League schools; (2) the proposed merger between Butterworth Health and Blogett Memorial; (3) the proposed acquisition of Novazyme Pharmaceutical by Genzyme; and (4) recent antitrust litigation against MasterCard and Visa. Together, the papers in this issue highlight an important success for the literature: that recent research in behavioral industrial organization is insightful for policy makers concerned with fostering market competition, protecting consumers, or improving market efficiency. At the same time, the papers in this issue also make clear that there are still many open questions, and it remains a fruitful area for future research.
References Angner, E., & Loewenstein, G. (2012). Behavioral economics. In Ma¨ki, U. (Ed.), Philosophy of economics (pp. 641–689). North-Holland, Amsterdam. Volume 13 of the Handbook of the Philosophy of Science, series editors Gabbay, Dov M., Thagard, Paul, and Woods, John. Armstrong, M. (2015). Search and ripoff externalities. Review of Industrial Organization, 47(3), 272–302. doi:10.1007/s11151-015-9480-1. Bailey, E. M. (2015). Behavioral economics and U.S. antitrust policy. Review of Industrial Organization, 47(3), 355–366. doi:10.1007/s11151-015-9469-9. Eliaz, K., & Spiegler, R. (2015). Beyond ‘‘Ellison’s matrix’’: New directions in behavioral industrial organization. Review of Industrial Organization, 47(3), 259–272. doi:10.1007/s11151-015-9470-3. Ellison, G. (2006). Bounded rationality in industrial organization. In Blundell, R., Newey, W. K., & Persson, T. (Eds.), Advances in economics and econometrics: Theory and applications, ninth world congress (Vol. 2, Chap. 5, pp. 142–174). New York: Cambridge University Press. Grubb, M. D. (2015a). Behavioral consumers in industrial organization: An overview. Review of Industrial Organization, 47(3), 247–258. doi:10.1007/s11151-015-9477-9. Grubb, M. D. (2015b). Failing to choose the best price: Theory, evidence, and policy. Review of Industrial Organization, 47(3), 303–340. doi:10.1007/s11151-015-9476-x. Heidhues, P., & K}oszegi, B. (2015). On the welfare costs of naivete´ in the US credit-card market. Review of Industrial Organization, 47(3), 341–354. doi:10.1007/s11151-015-9473-0. Rabin, M. (1998). Psychology and economics. Journal of Economic Literature, 36(1), 11–46. Simon, H. A. (1955). A behavioral model of rational choice. The Quarterly Journal of Economics, 69(1), 99–118. doi:10.2307/1884852. Spiegler, R. (2011). Bounded Rationality and Industrial Organization. New York: Oxford University Press. Tremblay, C. H., & Tremblay, V. J. (2012). New Perspectives on Industrial Organization: With Contributions from Behavioral Economics and Game Theory. New York: Springer Press.
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