Dynamic efficiencies of the 1997 Boeing‐McDonnell Douglas merger

We evaluate the welfare effects of the 1997 Boeing‐McDonnell Douglas merger in the medium‐sized, wide‐body aircraft industry. We find that the merger led to lower prices. To explain the price drop, we develop a dynamic oligopoly game with learning‐by‐doing. We quantify the welfare effects of the merger by incorporating both increased market power and merger efficiencies from accelerated learning‐by‐doing. Our dynamic analysis indicates that net consumer surplus increased by as much as $5.14 billion, whereas a static model ignoring efficiencies of learning‐by‐doing predicts a $0.92 billion loss.     

Valuing product innovation: genetically engineered varieties in US corn and soybeans

We develop a discrete‐choice model of differentiated products for US corn and soybean seed demand to study the welfare impact of genetically engineered (GE) crop varieties. Using a unique data set spanning the period 1996–2011, we find that the welfare impact of the GE innovation is significant. In the last five years of the period analyzed, our preferred counterfactual indicates that total surplus due to GE traits was $5.18 billion per year, with seed manufacturers appropriating 56% of this surplus. The seed industry obtained more surplus from GE corn, whereas farmers received more surplus from GE soybeans.     

The benefits of expediting government gold sales

Additional gold can be made available either by mining at high cost (approximately $250 per ounce in 1997 dollars) or by mobilizing government stocks at zero cost. Governments own massive above-ground stocks but loan out only a small percentage of these stocks. Making all government gold available for private uses immediately through some combination of sales and loans maximizes total welfare from private uses, a consequence of the first welfare theorem. We simulate a calibrated version of our model to quantify the effects of liquidating government stocks on alternative dates. If governments sell immediately rather than never, total welfare increases by $340 billion; if they make an unanticipated sale in 20 years, $105 billion of that amount is lost. By depressing prices, such sales benefit depletion and service users but injure private owners of stocks above and below-ground. However, the injury to above-ground stock owners is more than offset by the benefits to service users—often the same individuals. Mine owners would be the principal losers; however, they could be compensated (twice over) from government sales revenue without any need for tax increases.     

Domestic airline alliances and consumer welfare

This article investigates the consumer welfare consequences of the recent code‐share agreement between Continental Airlines and Northwest Airlines. We develop a discrete choice model based on individual flight characteristics. This structural model recognizes that consumers (i) may have heterogeneous preferences for flight attributes, and (ii) may face different prices for the same flight. The empirical methodology also deals with the measurement error problem stemming from the absence of consumer‐level data on prices. The estimation results suggest that, whereas the code‐share agreement did not impact consumers significantly on average, it increased the average surplus of connecting passengers but decreased the average surplus of nonstop passengers. Interestingly, the magnitude of our welfare results may be attributed in large part to changes in product characteristics other than prices.     

The impact of consumer inattention on insurer pricing in the Medicare Part D program

The Medicare Part D program relies on consumer choice to provide insurers with incentives to offer low‐priced, high‐quality pharmaceutical insurance plans. We demonstrate that consumers switch plans infrequently and search imperfectly. We estimate a model of consumer plan choice with inattentive consumers and show that high observed premiums are consistent with insurers profiting from consumer inertia. We estimate the reduction in steady state plan premiums if all consumers were attentive. An average consumer could save $1050 over three years; government savings in the same period could amount to $1.3 billion or 1% of the cost of subsidizing the relevant enrollees.     

Competition leverage: how the demand side affects optimal risk adjustment

We study optimal risk adjustment in imperfectly competitive health insurance markets when high‐risk consumers are less likely to switch insurer than low‐risk consumers. Insurers then have an incentive to select even if risk adjustment perfectly corrects for cost differences. To achieve first best, risk adjustment should overcompensate insurers for serving high‐risk agents. Second, we identify a trade‐off between efficiency and consumer welfare. Reducing the difference in risk adjustment subsidies increases consumer welfare by leveraging competition from the elastic low‐risk market to the less elastic high‐risk market. Third, mandatory pooling can increase consumer surplus further, at the cost of efficiency.     

Competition in the Audit Market: Policy Implications

The audit market's unique combination of features—its role in capital market transparency, mandated demand, and concentrated supply—means it receives considerable attention from policy makers. We explore the effects of two market scenarios that have been the focus of policy discussions: mandatory audit firm rotation and further supply concentration due to the exit of a “Big 4” audit firm. To do so, we first estimate publicly traded firms' demand for auditing services, allowing the services provided by each of the Big 4 to be differentiated products. We then use those estimates to calculate how each scenario would affect client firms' consumer surplus. We estimate that, for U.S. publicly trade firms, mandatory audit firm rotation would induce consumer surplus losses of approximately $2.7 billion if rotation were required after 10 years and $4.7–5.0 billion if after only four years. We find similarly that exit by one of the Big 4 would reduce client firms' surplus by $1.4–1.8 billion. These estimates reflect only the value of firms' lost options to hire the exiting audit firm; they do not include likely fee increases resulting from less competition among audit firms. The latter could result in audit fee increases between $0.75–1.3 billion per year for mandatory rotation and $0.47–0.58 billion per year for the disappearance of a Big 4 audit firm. Such losses are substantial; by comparison, total audit fees for public firms were $11 billion in 2010.     

Prominence and consumer search

This article examines the implications of “prominence” in search markets. We model prominence by supposing that the prominent firm will be sampled first by all consumers. If there are no systematic quality differences among firms, we find that the prominent firm will charge a lower price than its less prominent rivals. Making a firm prominent will typically lead to higher industry profit but lower consumer surplus and welfare. The model is extended by introducing heterogeneous product qualities, in which case the firm with the highest‐quality product has the greatest incentive to become prominent, and making it prominent will boost industry profit, consumer surplus, and welfare.     

An empirical study of observational learning

This article provides an empirical examination of observational learning. Using data from an online market for music, I find that observational learning benefits consumers, producers of high‐quality music, and the online platform. I also study the role of pricing as a friction to the learning process by comparing outcomes under demand‐based pricing to counterfactual pricing schemes. I find that employing a fixed price (the industry standard) can hamper learning by reducing the incentive to experiment, resulting in less consumer surplus, but more expected revenue for the platform.     

The strategic use of download limits by a monopoly platform

We offer a new explanation for why platforms, such as Internet service providers and mobile‐phone networks, offer plans with download limits: through one of two mechanisms, doing so causes content providers to reduce prices or improve quality. This generates greater surplus for consumers, which a platform captures via higher consumer access fees. Even accounting for congestion externalities, a platform limits downloads more than would be welfare maximizing; indeed, by so much, that barring such practices can be welfare superior to what a platform would do. Paradoxically, a platform will install more bandwidth when it can restrict downloads than when it cannot.     

Product differentiation and efficiencies in the retail banking industry

We empirically quantify the welfare implications of bank entry in the United States between 2000 and 2008. We use a fully structural framework that combines a differentiated demand model with an endogenous product model to investigate the market outcomes. We find no evidence for under- or over-entry. Compared with the socially efficient outcome, there is a mild welfare loss resulting from banks entering wrong locations in product space. Compared with the observed outcome, consumer surplus drops by 20–38% and bank profits decline by 48–59% when banks are homogeneous. Therefore product differentiation significantly improves welfare under free entry.     

Quantifying the benefits of entry into local phone service

Local telecommunications competition was an important goal of the 1996 Telecommunications Act. We evaluate the consumer welfare effects of entry into residential local telephone service in New York State using household‐level data from September 1999 to March 2003. We address the prevalence of nonlinear tariffs by developing a discrete/continuous demand model that allows for service bundling and unobservable provider quality. We find that the average subscriber to the entrants' services gains a monthly equivalent of $2.33, or 6.2% of her bill, in welfare from competition. These gains accrue primarily from firm differentiation and new plan introductions rather than from price effects.     

Differential pricing when costs differ: a welfare analysis

This article analyzes the welfare effects of monopoly differential pricing in the important, but largely neglected, case where costs of service differ across consumer groups. Cost‐based differential pricing is shown to increase total welfare and consumer welfare relative to uniform pricing for broad classes of demand functions, even when total output falls or the output allocation between consumers worsens. We discuss why cost‐based differential pricing tends to be more beneficial for consumers than its demand‐based counterpart, third‐degree price discrimination. We also provide sufficient conditions for welfare‐improving differential pricing when costs and demands differ across consumer groups.     

Damaged durable goods

I analyze a durable‐goods monopolist's incentives to introduce a damaged good (a stripped‐down version of the original good) in an infinite‐horizon framework. The damaged good helps the monopolist to mitigate the Coasian time‐inconsistency problem. However, it may lead to a welfare reduction: low‐valuation buyers are induced to purchase the low‐quality damaged good early rather than buy the high‐quality original good later, and when the players are patient the surplus loss from quality reduction outweighs the gain from earlier consumptions. This welfare result contrasts with the previous literature based on a static framework.     

Estimation of cost efficiencies from mergers: application to US radio

This article estimates fixed‐cost efficiencies from mergers using a dynamic oligopoly model in which mergers and repositioning of products are endogenous. The inference is based on revealed preference approach selecting cost synergies that rationalize observed merger decisions. The estimates can be used to assess the total welfare impact of retrospective and counterfactual mergers. The framework is applied to estimate cost efficiencies after the 1996 deregulation of U.S. radio industry. Within the period of 1996 to 2006 the cost savings resulting from mergers amount to $1.2 billion per year (equally split across economies of scale and within‐format cost synergies).     

Population Ageing,Fiscal Pressure and Tax Smoothing: A CGE Application to Australia*

This paper analyses the fiscal pressure from population ageing using an intertemporal CGE model, applied to Australia, and compares the results with those of a recent government‐commissioned study. The latter study uses an alternative modelling approach based on extrapolation rather than optimising behaviour of consumers and firms. The deadweight losses from the fiscal pressure caused by population ageing are equivalent to an annual loss of consumption of $260 per person per year in 2003 dollars in the balanced‐budget scenario. A feasible degree of tax smoothing would reduce this welfare loss by an equivalent of $70 per person per year. Unlike the extrapolation‐based model, the CGE approach takes account of feedback effects of ageing‐induced tax increases on consumption and labour supply, which in turn impact on the ultimate magnitude of fiscal pressure and therefore tax increases. However, a counterfactual simulation suggests that the difference in terms of deadweight losses between the two modelling approaches is modest, at about $30 per person per year.     

Quantifying search and switching costs in the US auto insurance industry

I estimate demand for auto insurance in the presence of two types of market frictions: search and switching costs. I develop an integrated utility‐maximizing model in which consumers decide over which and how many companies to search and from which company to purchase. My modelling approach rationalizes observed consideration sets as being the outcomes of consumers' search processes. I find search costs to range from $35 to $170 and average switching costs of $40. Search costs are the most important driver of customer retention and their elimination is the main lever to increase consumer welfare in the auto insurance industry.     

Loss leading with salient thinkers

In various countries, competition laws restrict retailers' freedom to sell their products below cost. A common rationale, shared by policymakers, consumer interest groups and brand manufacturers alike, is that such “loss leading” of products would ultimately lead to a race-to-the-bottom in product quality. Building on Varian's (1980) model of sales, we provide a foundation for this critique, though only when consumers are salient thinkers, putting too much weight on certain product attributes. But we also show how a prohibition of loss leading can backfire, as it may make it even less attractive for retailers to stock high-quality products, decreasing both aggregate welfare and consumer surplus.     

Comparative advertising: disclosing horizontal match information

Improved consumer information about horizontal aspects of products of similar quality leads to better consumer matching but also to higher prices, so consumer surplus can go up or down, while profits rise. With enough quality asymmetry, though, the higher‐quality (and hence larger) firm's price falls with more information, so both effects benefit consumers. This occurs when comparative advertising is used against a large firm by a small one. Comparative advertising, as it imparts more information, therefore helps consumers. Although it also improves the profitability of the small firm, overall welfare goes down because of the large loss to the attacked firm.