Endogenous Privacy and Heterogeneous Mismatch Costs

ABSTRACT This study considers an incumbent firm and a newcomer competing in an old market and a new one in a modified Hotelling model. Consumers must pay a privacy cost to conceal their personal information. Otherwise, their personal information is left in the old market, and only the incumbent firm can utilize it. If mismatch costs are homogeneous across markets, both consumer and total surpluses are increasing with the privacy cost. However, if mismatch costs are sufficiently heterogeneous across markets, both consumer and total surpluses are maximized when the privacy cost is zero. If heterogeneity is intermediate, consumer (total) surplus is maximized at zero (at a positive) privacy cost. Our study suggests that heterogeneity in mismatch costs across markets plays an important role in the welfare effects of privacy cost.