Preference manipulation is a big problem for competitive markets

Let me take you back to introductory economic theory for a minute. In a competitive equilibrium framework, it is assumed that consumers have some fixed preference ordering over goods. Firms produce the goods that people want in order to maximise profits, consumers desire goods that increase their utility, a price is determined for those goods so that markets clear, and everybody is happy. In theory.

Embedded within this, at least to some extent, is that individuals have somewhat stable and consistent preferences. Now, we all know in reality this is not true. The study of economic psychology and behavioural economics has come into existence because of this reality. However, there is one truth about preference that is particularly worrying – the fact that it can be shaped by firms.

The fact that advertising and marketing exists, and is successful as an industry in and of itself, is evidence enough that it must work to some degree. There has been suggestion that the presence of advertising could directly harm subjective well-being. This is particularly relevant in the digital world, where we forego payment in exchange for agreeing to be bombarded with all manner of marketing material. However, even if advertising does not directly harm well-being, I would argue that it does indirectly by distorting the entire market.

Going back to our introductory economic theory framework, imagine that consumer’s preferences are not well-defined. Instead, firms have the ability to change what people demand in the first place. What are some of the possible implications? The very process of changing demand requires resources, which are technically wasted from an efficiency perspective (because advertising and marketing does not generate utility in and of itself). It increases market power problems and anti-competitive practices, since firms are trying to generate demand for their products irrespective of price. It may also lead to the production of something I think of as an ’empty good’ – a good that people wouldn’t never even think of demanding until a firm invents it and convinces you that you need it.

I appreciate that some of these may be genuine innovations, and it is important not to discourage these. The goods I am talking about in particular are those that do not contribute to innovation, but merely claim that they do. A firm may introduce a ‘new’ product that is perceived to be superior to an older one, but in reality adds nothing of value, and encourages waste in order to keep profits flowing.

What is the overall outcome? Resources are wasted. The environment may be damaged, both from an unnecessary use of raw materials and from the waste generated from disposal. Prices for goods may increase as the most successful preference manipulators obtain market share and power. And finally, consumers suffer. From the environmental damage. From the increase in prices. From the fact that their preferences are manipulated to the point where the goalposts of ‘utility maximisation’ drift further and further away.

What can we do? It seems that we first have to acknowledge that this is a problem. We then need to appreciate the fragile psychology of the human mind, and the fact that some sort of intervention is required in order to prevent exploitation. After all, firms exist by design as a vehicle to serve the needs of consumers as efficiently as possible. They are not there to be fed by consumers until they absorb all available surplus.