Antitrust & Competition Policy Blog

Editor: D. Daniel Sokol
University of Florida
Levin College of Law

Monday, April 15, 2019

Seemingly Exploitative Contracts

By: Pei-Cheng Yu (School of Economics, UNSW Business School, UNSW Sydney)
Abstract: This paper studies sequential price discrimination of sophisticated present-biased consumers in the credit market. The optimal contract utilizes present bias to improve screening by inducing certain consumers to over-consume and over-accumulate debt without the presence of naivete. This shows that the optimal contract can have seemingly exploitative features that cause certain consumers to experience ex-post welfare losses even when they are sophisticated. This has important policy implications. If the intention of firms is to screen and not exploit consumers, then financial regulations aimed at protecting consumers by eliminating seemingly exploitative features could introduce additional distortions. I also analyze the optimal contract for naive consumers. The main difference between contracts for sophisticated and naıve consumers is the lack of a commitment mechanism in exploitative contracts, while the presence of teaser rates, late fees or overdraft fees does not necessarily make contracts exploitative.
Keywords: Credit contract, Financial regulations, Non-linear pricing, Present bias, Sequential screening
JEL: D18 D82 D86 G28
Date: 2018–10

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