In a recent book, titled Seduction by Contract: Law, Economics and Psychology in Consumer Markets, I studied consumer contracts and argued that the design of these contracts can be explained, in large part, as a response by sophisticated sellers to the imperfect rationality of consumers. In the terminology of Akerlof and Shiller, I was looking at contractual design as a phishing strategy. Of course, contractual design in consumer markets is but one example of the pervasive phishing that Akerlof and Shiller document. But it is an important example, so I will discuss it briefly.
Consumers routinely enter into contracts with providers of goods and services—from credit cards, mortgages, cell phones, insurance, cable TV, and Internet services to household appliances, theater and sports events, health clubs, magazine subscriptions, transportation and more. Consumer contracts are the product of an interaction between market forces and consumer psychology. They provide short-term benefits, while imposing long-term costs (think credit card teaser rates) – because consumers are myopic and optimistic. They are excessively complex (with multi-dimensional pricing structures, not to mention endless fine print) – because complexity allows sellers to hide the true cost of the product or service from the imperfectly rational consumer. Consumers are seduced by contracts that increase perceived benefits, without actually providing more benefits, and decrease perceived costs, without actually reducing the costs that consumers bear.
Like Akerloff and Shiller, I found that competition does not always alleviate this behavioral market failure. Indeed, competition may even exacerbate the problem. Sellers, operating in a competitive market, have no choice but to align contract design with the psychology of consumers. A high-road seller who offers what she knows to be the best contract will lose business to the low-road seller who offers what the consumer mistakenly believes to be the best contract. Put bluntly, competition forces sellers to exploit the biases and misperceptions of their customers.