Add-On Pricing in Retail Financial Markets and the Fallacies of Consumer Education
forthcoming in the Review of Finance
SAFE Working Paper No. 47
IZA Discussion Paper No. 6061
CEPR Discussion Paper No. DP8636
43 Pages Posted: 1 Apr 2014 Last revised: 9 Sep 2016
Date Written: July 11, 2016
Abstract
We analyze the consequences of consumer education on prices and welfare in retail financial markets when some consumers are naive about shrouded add-on prices and banks try to exploit this. Allowing for different information and pricing strategies we show that education is unlikely to push banks to full price disclosure, which would be efficient, but instead to a new equilibrium in which banks discriminate between consumer types. Welfare analysis reveals that education, while positive for consumers who learn to make better financial decisions, imposes a negative externality on other consumers when banks respond by setting higher prices. Overall, the welfare effects of consumer education can be negative. Our results identify important pitfalls policy makers should take into account when considering the seemingly harmless intervention of consumer education.
Keywords: consumer education, financial literacy, pricing strategies, bounded rationality, welfare effects
JEL Classification: D40, D80, L50
Suggested Citation: Suggested Citation