Working Paper: CEPR ID: DP18476
Authors: Shota Ichihashi; Alex Smolin
Abstract: We analyze a bilateral trade model in which the buyer's value for the product and the seller's costs are uncertain, the seller chooses the product price, and the product is recommended by an algorithm based on its value and price. We characterize an algorithm that maximizes the buyer's expected payoff and show that the optimal algorithm underrecommends the product at high prices and overrecommends at low prices. Higher algorithm precision increases the maximal equilibrium price and may increase prices across all of the seller's costs, whereas informing the seller about the buyer's value results in a mean-preserving spread of equilibrium prices and a mean-preserving contraction of the buyer's payoff.
Keywords: algorithmic consumption
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Price influences algorithmic recommendations (D49) | Algorithm underrecommends products at high prices (D49) |
| Price influences algorithmic recommendations (D49) | Algorithm overrecommends at low prices (D43) |
| Higher algorithm precision (C60) | Maximal equilibrium price increases (D41) |
| Higher algorithm precision (C60) | Higher prices across all seller costs (D49) |
| Buyer-optimal algorithm (D44) | Higher-cost sellers post higher prices (D49) |
| Buyer-optimal algorithm (D44) | Lower trade volume for higher-cost sellers (F12) |
| Enhancing algorithmic precision (C60) | Universal price increase (P22) |
| Enhancing algorithmic precision (C60) | Greater consumer welfare (D69) |
| Algorithm neutralizes effects of price discrimination (D43) | Protects consumers against adverse pricing strategies (L11) |
| Algorithm neutralizes effects of price discrimination (D43) | Promotes societal welfare (D69) |
| Informing the seller about the buyer's value (D44) | Mean-preserving spread of equilibrium prices (D53) |
| Informing the seller about the buyer's value (D44) | Mean-preserving contraction of the buyer's payoff (D11) |