Economics at the FTC: Hospital Mergers,Authorized Generic Drugs,and Consumer Credit Markets

Economists at the Federal Trade Commission pursue the agency’s competition and consumer protection missions. In this year’s essay, in antitrust, we discuss various aspects of our hospital merger analyses as well as the effects of authorized generic drugs on consumers and competition. In consumer protection, we describe two ongoing studies on the use of credit-based insurance scores to price homeowners insurance, and the accuracy of consumers’ credit reports that are provided by credit bureaus.     

Economics at the FTC: Data Intensive Mergers and Policy R&D

Economics at the Federal Trade Commission (FTC) supports both the competition and consumer protection missions of the agency. In this year’s essay we discuss a range of activities focusing on data-intensive antitrust cases in the hospital and consumer products industries. We also discuss our most recent work on gasoline pricing. Policy-focused research and competition advocacy takes center stage as we discuss some health care advocacy work in the administration of pharmaceutical insurance benefits and efforts to understand the real estate business more completely. Finally, we describe our efforts to quantify the extent of “identity theft”.     

Economics at the FTC: Physician Acquisitions, Standard Essential Patents, and Accuracy of Credit Reporting

Economists at the Federal Trade Commission pursue the agency’s competition and consumer protection missions. In this year’s essay, with respect to antitrust we discuss the analysis that is used in two areas where the Commission has recently been active: physician combinations and standard essential patents. In consumer protection, we discuss the FTC’s recently released national study of the accuracy of consumer credit reports.     

Estimating Market Power with Weak A Priori Information: An Exploratory Approach to the Model-Specification Problem

Choosing the wrong theoretical model to describe an industry??s behavior may lead to biased estimates of the degree of market power. This paper presents a two-step, data-driven methodology to reduce the risk of mis-specification bias. In the first step, a sliced inverse regression identifies the significant factors that affect the industry??s pricing behavior. In the second step, a non-parametric regression of price on the SIR factors estimates the link functions. The output of the algorithm offers useful information to identify the model that best approximates the industry??s pricing behavior. In addition, the output of the algorithm is used to develop a post-estimation test for model specification.     

Third-Degree Price Discrimination in Oligopoly when Markets are Covered*

We analyze oligopolistic third-degree price discrimination relative to uniform pricing when markets are covered. Pricing equilibria are critically determined by supply-side features such as the number of firms and their marginal cost differences. It follows that each firm's Lerner index under uniform pricing is equal to the weighted harmonic mean of the firm's relative margins under discriminatory pricing. Uniform pricing then lowers average prices and raises consumer surplus. We can calculate the gain in consumer surplus and loss in firms' profits from uniform pricing based only on the market data of the discriminatory equilibrium (i.e., prices and quantities).     

Cursed Consumers and the Effectiveness of Consumer Protection Policies*

We model firms' quality disclosure and pricing in the presence of cursed consumers, who fail to be sufficiently skeptical about undisclosed quality. We show that cursed consumers are exploited in duopoly if firms are vertically differentiated, if there are few cursed consumers, and if average product quality is high. Three common consumer protection policies that work under monopoly, that is, mandatory disclosure, third party disclosure and consumer education, may all increase exploitation and decrease welfare. Even where these policies improve welfare, they often lead to a reduction in consumer surplus. Our conclusions hold in extensions with endogenous quality and horizontal differentiation.     

Identifying customer behavioral factors and price premiums of green building purchasing

In recent years, global urbanization and overdevelopment have resulted in environmental degradation and an energy crisis. Promoting green buildings is among the most effective methods for achieving environmental sustainability. Although the initial costs of green buildings are higher than those of ordinary buildings, people perceive that the environmental benefits of green buildings justify their higher price premiums. From a developer's perspective, devising optimal pricing strategies according to customer-perceived prices and developers' expected profit is complex and difficult. Hence, in this study, we developed a framework based on the Howard–Sheth model of consumer behavior to identify behavioral factors that may affect consumer purchases of green buildings. An artificial neural network (ANN) was then used to develop a pricing model for predicting the price premiums of green buildings. The results revealed that the ANN model's overall prediction capability was 94%; the model's robustness was demonstrated by comparing the results produced using the model with those produced using a multiple regression analysis. In addition, the characteristics of consumers who were willing to accept higher price premiums for green buildings were identified and discussed. The proposed model can be applied as an effective decision-support tool for green building pricing and formulating marketing strategies.     

Music for a Song: An Empirical Look at Uniform Pricing and Its Alternatives

With digital music as its context, this paper quantifies how much money would be made using alternatives to uniform pricing. Using survey‐based data on nearly 1,000 students' valuations of 100 popular songs in early 2008 and early 2009, we find that various alternatives can raise both producer and consumer surplus. Digital music revenue could be raised by between a sixth and a third relative to profit‐maximizing uniform pricing. While person‐specific uniform pricing can raise revenue by over 50 per cent, none of the non‐discriminatory schemes raise revenue's share of surplus above 40 per cent of total surplus.     

Pricing strategy and moral hazard: Copay coupons in pharmaceuticals

Branded drug manufacturers issue copay coupons to compete with generics as their brands are coming off patent. To explore the impact of copay coupons on pricing and welfare, I estimate a model of demand and supply using data on sales, advertising, and copayment for cholesterol-lowering drugs and perform a counterfactual analysis to simulate equilibrium pricing with copay coupons used for price discrimination and moral hazard. Copay coupons issued for price discrimination make the drug with coupons affordable for more consumers and increase consumer welfare even when a small fraction of consumers receive a coupon. Coupons used for moral hazard significantly mitigate price competition and improve consumer welfare only when coupon penetration is sufficiently high.     

Economics at the FTC: Mergers,Dominant-Firm Conduct,and Consumer Behavior

Economists at the Federal Trade Commission (FTC) pursue the agency’s competition and consumer protection missions. In this year’s essay, in antitrust, we discuss the new Merger Guidelines, three exclusion cases, and R&D issues in the Thoratec/HeartWare merger and the Google/AdMob merger. In consumer protection, we discuss the FTC’s new rule on debt settlement, our efforts to improve disclosures, and our recent work on appliance energy disclosures.     

Product Line Rivalry and Market Segmentation—with an Application to Automobile Optional Engine Pricing

This paper addresses the questions whether and when the pricing practices on base products may differ from those of premium products, sold with options or add-ons. Various alternative models are considered: a monopoly model, a model of brand rivalry with full consumer information and a model of rivalry in which consumers are only well informed about base product prices. Only the brand rivalry model with limited consumer information predicts that premium products have larger percentage markups than base products, provided that brand rivalry is sufficiently intense. Empirical evidence on base and premium product pricing in the automobile market is consistent with the limited information model and inconsistent with the other two models.     

Elasticity of demand and behaviour-based price discrimination

Behaviour-based price discrimination (BBPD) is typically analysed in a framework characterised by perfectly inelastic demand. This paper provides a first assessment of the role of demand elasticity on the profit, consumer and welfare effects of BBPD. We show that the demand expansion effect, that is obviously overlooked by the standard framework with unit demand, plays a relevant role. In comparison to uniform pricing, we show that firms are worse off under BBPD, however, as demand elasticity increases the negative impact of BBPD on profits gets smaller. Despite a possible slight increase in the average prices charged over the two periods in comparison to uniform pricing, we show that BBPD boosts consumer surplus and that this benefit is independent of elasticity. In contrast to the welfare results derived under the unit demand assumption, where BBPD is always bad for welfare, the paper shows that BBPD can be welfare enhancing if demand elasticity is sufficiently high.     

Applying Hedonic Pricing Models and Factorial Surveys at Parker Pen to Enhance New Product Success

Walking the path from new product concept to successful commercialization is a tightrope act. Product developers must carefully balance a variety of factors, including predictions of consumer price sensitivity as well as which combination of product attributes will be most valued by the intended market. A well-chosen mix of analytical tools can enhance a firm's chances of accurately predicting market demand. Chuck Tomkovick and Kathryn E. Dobie describe how the integration of two product attribute assessment techniques–hedonic pricing models and factorial surveys–allows product designers to more accurately gauge price sensitivity and market receptivity to new product designs. They also describe how these analytical tools were used to improve decision-making in product development at the Parker Pen Company, and they discuss the role these tools can play in facilitating the transition from concept to commercialization. Hedonic price analysis is an econometric method for determining the value purchasers place on attributes of existing products. In product development, factorial surveys are used to identify the value members of the target market place on new product concepts and prototypes. When used in combination with identified hedonic prices, the responses to a factorial survey allow product developers to predict consumer willingness-to-pay for various combinations of new product attributes. Following development of prototypes for two new product lines, product developers at the Parker Pen Company used hedonic pricing models and factorial surveys as a means for reducing demand uncertainty and for clarifying what consumers were willing to pay for various combinations of product attributes that were under consideration. The integration and use of these techniques involved a five-step process of target market identification, product attribute identification, hedonic price estimation, administering of the factorial survey, and determination of consumer willingness-to-pay. The results of these analyses allowed Parker Pen to better focus product development efforts on those design elements for which test market customers indicated both demand and willingness-to-pay. The Parker Pen Company found hedonic pricing and factorial surveys useful for predicting both the rate and the degree of change in consumers' marginal utility for specific product attributes. The usefulness of these techniques also extends beyond the early stages of new product conception. These techniques are helpful in the development and implementation of dynamic new product marketing mix strategies, including such elements as product design, pricing, channel selection, and promotion.     

Pure vs. mixed commodity bundling

In the commodity bundling literature, pure bundling is ruled out as a uniquely optimal strategy because mixed bundling is always (weakly) better. This paper provides a theoretical distinction between the two pricing schemes. The distinction relies on the degree of consumer heterogeneity in reservation prices. While there is a lack of empirical evidence on commodity bundling pricing schemes due to the difficulties in measuring consumer heterogeneity, we circumvent this problem by examining firm heterogeneity. Specifically, we use data from the newspaper industry in which some two edition newspaper firms are mixed bundlers and others are pure bundlers.     

Economics at the FTC: Pharmaceutical Patent Dispute Settlements and Behavioral Economics

Economics at the Federal Trade Commission (FTC) supports both the competition and consumer protection missions of the agency. In this year’s essay we discuss two issues, one from each of the agency’s missions. First, we focus on intellectual property issues in pharmaceuticals. Specifically, we discuss the principal rationale for antitrust concerns about certain patent dispute settlements in the ethical drug industry. Then, we discuss consumer economics, our recent behavioral economics conference, and how behavioral economics influences our thinking about consumer policy.     

The Effect of Explicit Communication on pricing: Evidence from the Collapse of a Gasoline Cartel

We study the collapse of collusion in Québec's retail gasoline market following a Competition Bureau investigation, and show that it involved two empirical regularities: high margins, and asymmetric price adjustments. Using weekly, station‐level prices we test whether collusion was successful, and whether asymmetric adjustments were part of the cartel's strategy. We do so in the markets targeted by the investigation, and in markets throughout the province with similar pre‐collapse pricing (cyclical markets). Our results suggest that stations in both target and cyclical markets adjusted pricing following the announcement: margins fell (by 30%/15% in target/cyclical markets), and adjustments became more symmetric.     

Multiproduct retailing and consumer shopping behavior: The role of shopping costs

We empirically examine the role of shopping costs in consumer shopping behavior in a context of competing differentiated supermarkets that supply similar product lines. We develop and estimate a model of demand in which consumers can purchase multiple products from multiple stores in the same week, and incur transaction costs of dealing with supermarkets. We show that a similar model without shopping costs predicts a larger proportion of multistop shoppers and overestimates own-price elasticities and product markups. Further, we use our model along with a model of competition between supermarkets to study two practices that are commonly used by supermarkets: product delisting and loss-leader pricing. We show that the presence of shopping costs makes product delisting less profitable whereas it makes loss-leader pricing more profitable compared to a context in which consumers do not incur shopping costs.     

Personalized pricing and price fairness

Mobile web technology enables discriminatory, or personalized, pricing for many more consumer good categories than has traditionally been the case. Setting prices according to individual valuations, however, generates adverse consumer reaction unless consumers are invited to participate in the price-formation process. Consumer perceptions of price fairness are key to the sustainability of any discriminatory pricing regime. Perceptions of price fairness, in turn, are hypothesized to be shaped by “self-interested inequity aversion” in which prices tend to be regarded as unfair, and purchase probabilities fall, if others are perceived to pay a lower price, while prices tend to be regarded as more fair, and consumers more likely to purchase, if inequity is in the buyers favor. Our experimental data also shows that the implications of inequity aversion for sellers can be at least partially reversed if consumers are allowed to participate in the price-formation process by negotiating the price they pay. The primary implication of our findings is that, in order to be viable, any system of discriminatory pricing for consumer goods should invite consumers to have a stake in the price they pay. Such participatory pricing may provide one way out of the current trap of Hi–Lo, or promotional, pricing that neither retailers nor manufacturers regard as sustainable.     

Platform Pricing at Sports Card Conventions

We study a new data set of U.S. sports card conventions from the perspective of the pricing theory of two‐sided markets. Conventions are two‐sided because organizers must set fees to attract both consumers and dealers. We present several findings: first, consumer pricing decreases with competition, but pricing to dealers is insensitive to competition and in longer distances even increases with competition. Second, when consumer price is zero (and thus constrained), dealer price decreases more strongly with competition. These results are compatible with existing models of two‐sided markets, but are difficult to explain without such models.     

How Do Consumer Characteristics Affect the Bias in Measuring Willingness to Pay for Innovative Products?

Getting the price right is essential for successful new product introductions. An accurate estimate of consumers' willingness to pay is a crucial part of this task. Measurement of willingness to pay for innovations, however, often yields biased results. In this paper, we investigate consumer‐related characteristics and motives that might underlie this bias. Drawing on the elaboration likelihood model, we develop a conceptual model to identify consumer characteristics relevant for preference measurement for innovative products. In doing so, two main factors that potentially influence hypothetical bias are distinguished: ability and motivation. Our conceptual discussion and empirical results demonstrate that the validity of willingness to pay statements is higher among consumers who show a high ability to assess the new product's utility and who are truly interested in purchasing the new product. Counter to intuition, willingness to pay statements from innovators, consumers with good product category knowledge, or consumers who perceive the new product to be highly innovative are relatively more biased and should be interpreted with caution. This research is among the first to look at consumer characteristics rather than methodological issues when it comes to measuring consumer willingness to pay for innovative products. Our conceptual discussion and empirical examination of the drivers of hypothetical bias can be used to refine the validity of the results of the direct willingness to pay approach. These findings should help improve new product pricing surveys and open new avenues for research in measuring consumer preferences.