Exogenous Versus Endogenous Consumer Time Preferences: Oligopoly

Abstract

We propose a dynamic framework with consumers who have different valuations and an arbitrary number of firms that compete in quantities in each period. The consumers’ ability to behave strategically about the timing of consumption differs in the three distinct cognitive structures that we study: Under perfect rationality, consumers are strategic. Under extreme bounded rationality, consumers are myopic. Under explicit bounded rationality, consumers start the game myopic and can become strategic by incurring a cost. We make three contributions: First, we examine how the welfare of consumers is affected when new firms enter the industry, ceteris paribus. We find that under perfect rationality no consumers are worse off with a larger number of firms, whereas under extreme and explicit bounded rationality, some consumers may be worse off. Second, we reevaluate the profitability of exogenous horizontal mergers. We prove that mergers in which the merging firms represent more than 80% of the industry may be unprofitable. This outcome appears under explicit bounded rationality and represents a new merger paradox. Third, we demonstrate that, under explicit bounded rationality, an increase in the cognition cost, ceteris paribus, may decrease profits per firm. One can view the cognition cost as relevant to the transparency of the market. Thus, our finding questions the benefits from less transparent markets for oligopolistic firms.