Sequential Cognition and Product Flexibility

We study a bilateral trade environment in which a seller exerts cognitive efforts to identify the optimal product design for a buyer. Should the seller fail to discover the innovative design, he has the option to induce additional cognition from the buyer by making the product flexible at an additional cost. We show that sequential cognition is more likely to occur in the decentralized equilibrium than in the first-best case. Furthermore, the seller always under-provides cognition, while the buyer may incur excessive cognitive costs in equilibrium. In an extended model, we find that the seller may further decrease cognitive efforts when facing competition