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Bounded Rationality in Industrial Organization (BRIO)
Start date: 01 Nov 2008, End date: 31 Oct 2014 PROJECT  FINISHED 

"Economists' modern understanding of the functioning of markets is based on the behavioral assumption of individual rationality. Market agents are assumed to hold well-defined preferences and have perfect ability to draw Bayesian inferences in accordance with correct knowledge of the market model and market equilibrium. This research proposal is based on the premise that bounded rationality on the part of consumers is potentially a major source of market friction. My objective is to develop general theoretical tools to investigate this intuition, and to examine whether these tools can be insightfully applied to realistic market settings. So far, the literature on the subject has progressed as a sequence of specific models that capture one aspect of consumer psychology at a time. The challenge is to synthesize and generalize these models into flexible theoretical frameworks for modelling market interaction between profit-maximizing firms and boundedly rational consumers. Hopefully, various aspects of consumer psychology can be embedded into these frameworks, so that analytic results can be stated in terms of general, abstract properties of consumer behavior, rather than in terms of specific psychological effects. In turn, this general analysis is expected to lead to novel applications. Here are some of the general questions that I hope to address. Can we view certain aspects of firms' pricing and marketing strategies as responses to consumers' bounded rationality? To what extent are boundedly rational consumers vulnerable to exploitation by firms? Does competition protect them from exploitation? Does interaction between firms and boundedly rational consumers give rise to inefficiencies, and how are these affected by competition? What is the impact of various regulatory interventions in this context? Do market forces lead firms to ""educate"" or ""debias"" boundedly rational consumers? Does greater consumer rationality imply more competitive industry profits?"
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