Fabian Herweg and Antonio Rosato
We analyze a model of price competition between a transparent retailer and a deceptive one in a market where a fraction of consumers is naïve. The transparent retailer is an independent shop managed by its owner. The deceptive retailer belongs to a chain and is operated by a manager. The two retailers sell an identical base product, but the deceptive one also offers an add‐on. Rational consumers never consider buying the add‐on while naïve ones can be “talked” into buying it. By offering the manager a contract that pushes him to never sell the base good without the add‐on, the chain can induce an equilibrium in which both retailers obtain more‐than‐competitive profits. The equilibrium features price dispersion and market segmentation, with the deceptive retailer targeting only naïve consumers whereas the transparent retailer serves only rational ones.