An experimental study on the sale of counterfeit products under monitoring policies

This study examines the decision behaviour of a seller who may sell either a genuine product or a deceptive counterfeit product under a monitoring policy characterised by an inspection frequency and a penalty level. A unique feature of selling deceptive counterfeit products is that the seller incurs significant losses when the deceptive counterfeit product is inspected, but enjoys significant gains if it is not. We conduct a laboratory experiment to investigate the seller’s behaviour regarding his/her selling strategy. In contrast to the standard theoretical predictions, we observe that the seller’s strategy exhibits a “deviate-to-equal-probability” effect, a diminishing marginal impact of the penalty level, and dynamic behavioural biases such as the “gambler’s fallacy” and speculation. A behavioural model is developed using bounded rationality and prospect theory to describe the observed behaviours, including the perception of the inspection probability in an inverse “S-shaped” pattern. Our results imply that, when designing effective monitoring policies, policymakers need to discreetly choose inspection frequencies depending on the penalty levels and to take into account sellers’ dynamic behavioural biases.