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On the feasibility of market solutions to self-control problems

Summary I consider behavior and welfare in competitive markets supplying harmful or beneficial goods when consumers, at each moment in time, prefer immediate gratification more than they would themselves approve. In a spot market and without advance commitment to her consumption level, a decision maker overconsumes harmful goods and underconsumes beneficial goods from her own point of view. The optimal level of consumption can be achieved by adjusting prices in a way that forces a consumer to fully internalize the future consequences of consumption. Calibrations in the case of tobacco and exercise indicate that the optimal interventions can be very large. I examine the extent to which market forces can provide such “selfcontrol” interventions, when firms and consumers can agree on price schedules ex ante. If consumers are bound to the firm whose offer they accept and price schedules are restricted to two-part tariffs, consumption is much closer to optimal than in a spot market. But if consumers cannot be prevented from purchasing from other firms ex post, the consumption of harmful goods is as if only a spot market was available. And if firms can engage in non-linear pricing, perfectly sophisticated consumers consume optimally in equilibrium, but individuals with an arbitrarily small amount of overoptimism regarding their self-control problem consume as if they were buying on the spot market. Hence, government intervention may typically be necessary to correct self-control problems.