The 2017 Nobel Prize in economics was recently awarded to Richard Thaler, one of the founding fathers of the movement known as 'behavioural economics'. Fifteen years ago, Daniel Kahneman also won the prize for his contribution to the relationship between psychology and economics. Behavioural economics emerged in literature at the end of the 1970s with the work of Kahneman and Tversky and their prospect theory.(1) Ever since, the area has evolved in academia, public policy and even in non-technical fields.
According to traditional antitrust theory, individuals (and firms) maximise utility according to stable preferences and rational expectations, while being well informed. This means that antitrust follows microeconomic bases that lead to the assumption that economic players are rational actors with willpower and self-interest. However, the emergence of behavioural economics shows that people do not necessarily behave in the ways that traditional economic principles – which created the famous homo economicus – would predict.
Behavioural economics challenges traditional microeconomics assumptions in three domains of research:
- bounded rationality;
- bounded willpower; and
- bounded self-interest.
Bounded rationality relates to "judgement errors and departures from expected utility theory".(2) Bounded willpower deals with individuals' lack of patience and poor decision making. Finally, bounded self-interest relates to individuals' goals and fairness. All of these limits play different roles in people's everyday lives. For example, while bounded rationality applies when individuals need to "assess the probability of an uncertain event" and value outcomes, bounded willpower comes into play when individuals make decisions over time. But how does this affect antitrust?
Around 10 years ago, Stucke noted that, despite being the "hottest area of legal scholarship", behavioural economics would not be the subject of work in the antitrust field.(3) This scenario changed substantially during the past few years and, now, several studies deal with the intersection between behavioural economics and antitrust – to the extent that it is now referred to as 'behavioural antitrust'.(4)
This update explores the three perspectives in which behavioural economics can be useful in the antitrust practices of individuals, firms and antitrust agencies.
Individuals' perspective and abuse by firms
Behavioural economics is useful for firms seeking to improve their sales, as it allows them to understand and use individuals' heuristics (ie, simple, efficient rules which people often use to form judgements and make decisions) and biases. For example, the status quo bias (or endowment effect, which is the tendency for individuals to value what they own more) may be important for a firm that wants to enter the market and needs to compensate for this bias by offering a lower switching cost. Loss aversion bias also plays an important role in marketing strategies. The legality of framing certain price differences as surcharges or discounts has been debated in the courts – in particular, how merchants can describe their pricing practices. Finally, individuals under and overestimate the likelihood of low-probability events based on the information availability. In fact, availability heuristics is one of the main reasons for advertisements and sponsorships, since watching sports broadcasts and other shows constantly reminds consumers of specific brands. These three examples represent a small part of the spectrum of possibilities that behavioural economics opens to firms' marketing strategies. They challenge traditional economic antitrust deals which view individuals as rational actors with willpower and self-interest.
Could dominant players use behavioural economic strategies to abuse their position? According to the UK Office of Fair Trading (OFT), "where such [consumer] biases exist, firms can act to exacerbate and exploit them, at every stage in the decision-making process".(5) The OFT has identified four price-related practices adopted by companies in this regard:
- drip pricing (eg, when low-cost airlines charge additional fees for luggage, seat reservations and food only after disclosing a low fare);
- sales (eg, was $2, now $1 deals);
- complex pricing (eg, buy two, get one free deals); and
- baiting (eg, store-wide sales where only a small amount of reduced goods are offered).
This is what Huffman and Heidtke call 'behaviour exploitation'.(6) According to them, behavioural exploitation is a fourth category to the original three antitrust categories (ie, collusive conducts, monopolisation practices and merger control).
Regardless of this new category within antitrust, it is important for both market players and antitrust agencies to be aware of individuals' biases and possible abuses by dominant players. This applies, for instance, in cases where information on customers' behaviour is a key factor in the market. Further, behavioural economics may help agencies to better understand market dynamics when reviewing merger cases, and even when designing remedies that could better address their concerns.
Antitrust theory also assumes that firms are completely rational actors and thus can make logical and coherent choices based on the available information. However, this is not always the case; firms are formed by individuals, who by their nature are not completely rational. The bounded rationality, willpower and self-interest that individuals experience in their personal lives also exists when running their businesses. Further, when a group of people get together (eg, a board of directors), they will also have specific biases.
For example, firms are biased in their decision to enter into a market. Studies on the bounded rationality of entrepreneurship demonstrate that entries into the market are not always as rational as antitrust theory would predict. Fixed categories for analysing possible future entries (timely, likely and sufficient)(7) may fail to predict real entries. According to Tor, entrants struggle to predict future profitability, which reflects in the low performance average of start-ups.(8) Indeed, starting a business involves several risks and requires previous planning. Åstebro's work shows empirical evidence that the majority of entrants fail due to:
- risk preferences;
- overconfidence; and
- non-pecuniary benefits.(9)
Besides the bounded rationality of entrants, firms' everyday decision-making processes may be affected by certain limitations on rationality. Tor indicates that agents tend not to experience an endowment effect (when the individual values what he or she has more) and they have fewer egocentric biases when working on behalf of a firm. Further, according to him, evidence suggests that dominant firms and monopolists may consciously engage in high-risk, negative net present value predation under some circumstances.(10) Boards also exhibit (slightly) more rational behaviour because their members will have different viewpoints, experiences and methods of deliberation.
Although managers tend to be more rational because of their expertise, there is evidence that experts also experience systematic judgement and decision errors. Despite there being an overall picture of more rationality, boards may make systematic errors based on polarisation and groupthink. A firm's economic situation may also contribute to more or less rational behaviour. As Tor indicates, companies losing their market share may engage in non-rational predatory strategies that would differ from traditional antitrust theory.(11)
Again, behavioural economics may be useful for antitrust agencies to assess:
- the likelihood of an entry;
- the extent of rivalry in a market; and
- the (lack) of rationality of certain marketing practices.
Antitrust agencies' perspective
Besides individuals' and firms' bounded rationality, willpower and self-interest, antitrust agencies also face issues relating to their own bounded rationality. As Jolls, Sunstein and Thaler note, "government will often be subject to cognitive and motivational problems even if it is not populist (bureaucrats may also lack appropriate incentives to make decisions in the public interest)".(12)
The problem of antitrust agencies' bounded rationality was recently addressed by Cooper and Kovacic.(13) Adopting the behavioural economics framework, they offer some explanations about how antitrust agencies could be affected. According to them, regulators are subject to three main heuristics:
- availability, which relates to the weight that people give to recent and salient events;
- representativeness, which deals with the fact that people tend to overestimate probabilities because they ignore low baseline probability and small sample sizes; and
- hindsight bias, which involves the ex-post assessment of probability.
Based on these limitations, regulators are likely to emphasise recent and publicised events (availability) and create unrealistic probability estimates (representativeness). They may also under or overestimate the effects of certain practices after they occur (hindsight).
Behavioural economics plays an undeniably important role in the economy. Both market players and antitrust regulators are still learning about their own and others' bounded rationality, willpower and self-interest. And antitrust seems to be the place where these players are getting closer to having a strong understanding of these factors – something which could result in more profitability. Regardless, behavioural economics can help antitrust agencies to identify abuses, evaluate transactions and design more efficient remedies.
Of course, the use of behavioural economics within antitrust – or behavioural antitrust – does not exclude the use of traditional microeconomics theory. Nor does it deny the evolution of this field or the existing standards; instead, it seeks to fill the gaps where traditional economics falls short. It is a complementary tool for agencies to identify risks and abuses and predict behaviour.
This article was first published by the International Law Office, a premium online legal update service for major companies and law firms worldwide. Register for a free subscription.
For further information on this topic please contact Bruno Bastos Becker or Marcos Exposto at BMA Barbosa Müssnich Aragão by telephone (+55 21 3824 5800) or email ([email protected] or [email protected]). The BMA Barbosa Müssnich Aragão website can be accessed at www.bmalaw.com.br.
?Endnotes
(1) Daniel Kahneman and Amos Tversky, Prospect Theory: An Analysis of Decision under Risk, 47 Econometrica, 263,291 (1979).
(2) Christine Jolls, Behavioral Economics and the Law 11 (2011).
(3) Maurice E Stucke, Behavioral Economists at the Gate: Antitrust in the Twenty-First Century, 38 Loy U Chi LJ 513, 592 (2007).
(4) See, for example, Luca Arnaudo, The Quest for Behavioural Antitrust: Beyond the Label Battle, towards a Cognitive Approach, 2013 DQ 77, 79 (2013).
(5) Office of Fair Trading, What does Behavioural Economics mean for Competition Policy?14 (March 2010).
(6) Max Huffman; Daniel B Heidtke, Behavioral Exploitation Antitrust in Consumer Subprime Mortgage Lending, 4 Wm & Mary Pol'y Rev 77, 109 (2012).
(7) Department of Justice, 3. Entry Analysis (May 5 2017).
(8) Avishalom Tor, The Fable of Entry: Bounded Rationality, Market Discipline, and Legal Policy, 101 Mich L Rev. 482, 568 (2002).
(9) Thomas Åstebro, Holger Herz, Ramana Nanda and Roberto A Weber, Seeking the Roots of Entrepreneurship: Insights from Behavioral Economics, 28 J Econ Perspect. 49,51 (2014).
(10) Tor, Illustrating a Behaviorally Informed Approach to Antitrust Law: The Case of Predatory Pricing, 18 Antitrust 52, 55 (2003).
(11) Tor, The Market, the Firm, and Behavioral Antitrust, in the Oxford Handbook of Behavioral Economics and the Law 539, 554 (Eyal Zamir and Doron Teichman ed, 2014).
(12) Christine Jolls, Cass R Sunstein and Richard Thaler, A Behavioral Approach to Law and Economics, in Behavioral Law and Economics 48 (Cass R Sunstein ed, 2000).
(13) James C Cooper and William Kovacic, Behavioral Economics and Its Meaning for Antitrust Agency Decision Making, 8 JL Econ and Pol'y, 779, 800 (2012).
