Contractual structures and consumer misperceptions

Authors: Christian Michel

Journal of Economics and Management Strategy, December, 2017

We analyze how firms can design contracts to strategically induce consumer misperceptions. A fraction of consumers is naive and underestimates the costs of claiming a warranty payment in the event of product breakdown. This leads to an inference error that makes consumers prone to overpredict product quality, which a firm can profitably exploit. The channel persists under different market structures and can reduce the quality provision to sophisticated consumers. We argue that our results apply more generally to cases in which consumers are inattentive or illiterate with respect to contract fine print, and provide supporting evidence from TV infomercials.