Critics of consumer privacy protections frequently invoke revealed preference as a justification for laissez-faire policy. If users really cared about their privacy, the argument goes, we should expect to see revolts against intrusive practices. A number of scholars have demonstrated pervasive information asymmetries1 and bounded rationality2 in consumer privacy choices; the decisions that users actually make about online privacy can hardly be expected to reflect their actual preferences.
But let’s suppose that consumers and online firms are fully informed and completely rational. The economic story that consumers value their privacy less than the marginal income from privacy intrusions is certainly consistent with market behavior.
We should not, however, conclude that the status quo is optimal. There is another congruent economic story, where privacy intrusions are inefficient but nevertheless result owing to transaction costs and competition barriers. This post relates the alternative economic story with two possible examples, then closes with policy implications.