Privacy in Online Markets: A Welfare Analysis of Demand Rotations

Abstract

We compare the private and social incentives for privacy when sellers can commit to transparent privacy policies that are understood by consumers. The purpose is to establish a baseline for how well markets perform when firms' privacy policies are common knowledge. In this setting, if the market is competitive, the outcome is first best or firms provide too much privacy. For monopolized markets, we obtain new results for the welfare effects of demand rotations when preferences over the good and privacy are drawn from the location-scale family, which includes the normal (probit) and logistic (logit) models of demand. We discuss the nature of the distortions and implications for policy toward privacy and the market provision of product attributes generally.

Keywords: Privacy, Disclosure, Product Design, Advertising, Demand Rotation, Product Attributes

JEL Classification: D6, D8, L1, L5