Seduction by Contract

Abstract

Consumers routinely enter into long-term contracts with providers of goods and services — from credit cards, mortgages, mobile phones, insurance, TV, and internet services to household appliances, events, health clubs, magazines, and transportation. Across these consumer markets certain design features of contracts are recurrent, and puzzling. Why do sellers design contracts to provide short-term benefits and impose long-term costs? Why are low introductory prices so common? Why are the contracts themselves so complex, with numerous fees and interest rates, tariffs, and penalties? This book explains how consumer contracts emerge from the interaction between market forces and consumer psychology. Consumers are short-sighted and optimistic, so sellers compete to offer short-term benefits, while imposing long-term costs. Consumers are imperfectly rational, so sellers hide the true costs of products and services in complex contracts. 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 ultimately bear. Competition does not help this behavioural market failure. It may even exacerbate it. Sellers, operating in a competitive market, have no choice but to align contract design with the psychology of consumers. Put bluntly, competition forces sellers to exploit the biases and misperceptions of their customers. This book argues that better legal policy can help consumers and enhance market efficiency. Disclosure mandates provide a promising avenue for regulatory intervention. Simple, aggregate disclosures can help consumers make better choices. Comprehensive disclosures can facilitate the work of intermediaries, enabling them better to advise consumers. Effective disclosure would expose the seductive nature of consumer contracts and, as a result, reduce sellers' incentives to write inefficient contracts.

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