Why are there hidden fees?

Here is the bottom line:

Laibson and Gabaix’s explanation relies on a good bit of math, too, but
it can be summarized pretty simply using a hypothetical example.
Imagine two hotel chains. The first, Hidden Price Inn, has a very low
room rate of $80 a night, but makes liberal use of high "shrouded"
fees: Three bucks for a minibar Dr Pepper, $25 for parking, $12 for
eggs at breakfast. The unsophisticated traveler cheerily (if
unwittingly) forks over the fees, all the while patting herself on the
back for getting a cheap room.

Now imagine a second chain, Straightforward Suites. It charges much
more reasonably for the extra costs ($1, say, for that Dr Pepper), but
because it makes less on the extras, it has to charge slightly more for
the room-$95, instead of $80. Even an unsophisticated traveler can tell
$95 isn’t as good as $80.

Through an aggressive ad campaign, Straightforward could try to point
out how devious the approach of Hidden Price Inn is and how much less
deceptive its own prices are. But Laibson and Gabaix show that there’s
a catch in this strategy: Hidden Price Inn actually has two key types
of customers. Yes, there are the clueless consumers (the economists
prefer to call them "myopic"). But there are also the sophisticated
ones, who know that if they avoid the hotel restaurant, take a taxi
instead of using the parking garage, and call home with a cellphone,
they’ll actually get a better deal at Hidden Price than at

Straightforward Suites’s ad campaign, then, might just end up
increasing the ranks of sophisticated consumers who will in turn dial
up Hidden Price Inn for a cut-rate room. Rather than play this
self-defeating game, Straightforward will most likely just lower its
own room prices and stick it to the customers on the extras.

Here is the full story, by Christopher Shea.  The pointer is from www.politicaltheory.info.  Here are earlier versions of the paper.


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