Second, he systematically mispredicts how he will react when circumstances change, such as when incentives for forward-looking behavior increase or he is placed in a new, ex-ante identical environment. First, in basic settings he always comes to act in a more present-biased manner than a sophisticated agent. His unrealistic self-view does, however, manifest itself in several other ways. In many stable situations, a partially naive present-biased agent appears realistic in that he eventually predicts his behavior well. We study general properties of the model, and then apply the framework to identify novel implications of partially naive present bias.
We model an agent who stubbornly underestimates how much his behavior is driven by undesirable motives, and, attributing his behavior to other considerations, updates his views about those considerations. In non-selfish equilibria, a proportional subsidy on the clean product dominates both a unit tax and a cap.
In a selfish equilibrium, a cap and a unit tax on the dirty product can achieve the same outcomes. Under conditions we identify, this selfish equilibrium is the unique equilibrium. When there are two products that are perfect substitutes in consumption but generate different externalities, there is always an equilibrium in which the products have the same price and consumers are indifferent between them. Furthermore, under trade with a large or very polluting partner, a cap is better than a tax. To motivate consumers to lower the externality in a closed economy, a unit tax is superior to a cap-and-trade system, but there are policies that are better than a tax. Dampening implies that even if all consumers value the externality like the social planner, they mitigate too little in any equilibrium, and may coordinate on the worst of multiple equilibria. That impact on others endogenously dampens the consumer’s direct effect on the externality, undermining responsible behavior. In violation of price taking, a vanishingly small consumer cares about her impact on the behavior of the rest of the market to a non-vanishing extent. We model and analyze the market behavior of such “socially responsible consumers,” derive properties of the resulting competitive equilibria, and study the effectiveness of different policies. Many consumers care about climate change and other broad externalities.
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