Naivete-Based Discrimination
Abstract:
We initiate th
e study of naivete-based discrimination, the practice of conditioning offer
s on external information about a consumer’s naivete. We identify a broad c
lass of situations in which such discrimination lowers social welfare. In o
ur primary example, a credit market with time-inconsistent borrowers, impro
ving lenders’ information about borrowers’ short-run taste for immediate gr
atification (beta) or naivete about this taste (beta-hat) always lowers wel
fare. Because non-sophisticated borrowers underestimate their willingness t
o pay interest on a loan, lenders raise the amount of credit above optimal.
Information about consumers leads firms to raise inefficient lending to co
nsumers more likely to be naive and to lower inefficient lending to consume
rs more likely to be sophisticated, while raising total lending. We identif
y precisely what kind of information is welfare-decreasing. We show that in
formation that allows firms to learn about the naivete of consumers with gi
ven beliefs always strictly decreases total welfare, but information about
a consumer’s beliefs has at most distributional implications, while informa
tion about tastes is neither necessary nor sufficient to decrease welfare.
We show that the logic of our results extends to other markets, such as ban
k accounts or hotels, where consumer naivete may play a role and the distor
tion from exploiting naivete falls on both types of consumers. We also poin
t out important settings outside this class, and identify the effect of inf
ormation about naivete in those cases.