Industrial Organization Program Meeting

February 22 and 23, 2013
Ryan Kellogg, University of Michigan, and Gregory Lewis, Harvard University, Organizers

David Muir and Katja Seim, University of Pennsylvania, and Maria Ana Vitorino, University of Minnesota

Drip Pricing When Consumers Have Limited Foresight: Evidence from Driving School Fees

Muir, Seim, and Vitorino empirically investigate the add-on or "drip" pricing behavior of firms in the Portuguese market for driving instruction. They present a model along the lines of Gabaix and Laibson (2006) in which consumers purchase a base and, with some probability, an add-on product from the same firm, but are not always aware of the possible need for the add-on product. They show that a typical loss-leader pricing strategy emerges, whereby markups on the upfront product are lowered artificially, while firms price the add-on at monopoly levels. They then test the implications of the model using a detailed snapshot of industry data on student characteristics and preferences, school attributes including prices and costs, and market demographics for a cross-section of local markets with differing numbers of school competitors. They find significant evidence in support of the model's predictions, including that firms face a substantial profit motive in the add-on market. Most notably, markups for the base product, but not the add-on products, decline with the number of competitors a firm faces, a prediction that had not been established in the literature to date. Finally, they estimate an empirical version of the model to show that approximately one-quarter of students are not aware of the add-on when making their school choice. This result has important policy implications about the cross-subsidization from those students who are unaware of the add-on to those who are.

Sanjog Misra, University of California, Los Angeles, and Harikesh Nair and Oystein Daljord, Stanford University

Salesforce Composition and Compensation

Misra, Nair, and Daljord study the compensation and composition of a firm's sales force, assuming that the firm is restricted to setting either fully or partially uniform contractual terms across its entire sales force. In their model, the presence of a sales-agent in the firm indirectly affects the behavior of other agents in the pool, even when agents have exclusive territories, and there is no complementarity across agents or any substitution effects in output. The researchers present an empirical application to sales-force contracting at a Fortune 500 seller of contact lenses. They find that being restricted to using homogenous compensation plans significantly reduces the payoffs to the firm as compared to having a fully heterogeneous plan. However, if the firm can optimize both sales force composition and compensation, then its payoffs come very close to those of the fully heterogeneous plan. In this empirical setting, the ability to choose agents partially mitigates the loss in incentives from the restriction to uniform contracts.

Meghan Busse and Florian Zettelmeyer, Northwestern University and NBER, and Ayelet Israeli, Northwestern University

Repairing the Damage: The Effect of Price Expectations on Auto-Repair Price Quotes

Busse, Israeli, and Zettelmeyer show that price expectations alter outcomes in a negotiated price environment. By experimentally manipulating the price expectations that consumers communicate to firms, they show that those expectations alter outcomes by directly changing firms' behavior. The researchers implement a large-scale field experiment in which callers request price quotes from automotive repair shops. They find that repair shops quote higher prices if they know that the callers' perception of the market price is high, and that women are quoted higher prices than men when callers signal that they are uninformed about market prices. However, those gender differences disappear when callers mention an expected price for the repair. Finally, they find that repair shops are more likely to offer a price concession if asked to do so by a woman than a man.

Allan Collard-Wexler, New York University and NBER, and Jan De Loecker, Princeton University and NBER

Reallocation and Technology: Evidence from the U.S. Steel Industry (NBER Working Paper No. 18739)

Collard-Wexler and De Loecker measure the impact of a drastic new technology for producing steel – the minimill – on the aggregate productivity of U.S. steel producers. Using unique plant-level data covering 1963 to 2002, they find that the sharp increase in the industry's productivity is linked to this new technology and operates through two distinct mechanisms. First, minimills displaced the older technology, called vertically integrated production, and this reallocation of output was responsible for one third of the increase in the industry's productivity. Second, increased competition from the expansion of minimills drove a substantial reallocation process within the group of vertically integrated producers, in turn driving a resurgence in their productivity, and consequently the industry's productivity as a whole.

Francesco Decarolis, Boston University

What Does Medicare D Share with LIBOR and Procurement Auctions? The Distortionary Effects of the Low Income Subsidy

In Medicare Part D, low income individuals receive a subsidy for enrollment in insurance plans. Decarolis studies how the combined effects of this subsidy and the default assignment of low income enrollees into plans distort premiums. He concludes that removing this distortion could reduce the cost of the program without worsening consumers welfare. Using data from the the first five years of the program and an instrumental variable approach, he finds that the distortion has a large effect on the observed premium growth, especially for the premium component directly paid by Medicare.

Ying Fan, Kai-Uwe Kuhn, and Francine Lafontaine, University of Michigan

Financial Constraints and Franchising Decisions

Fan, Kuhn, and Lafontaine study how the financial constraints of agents affect the behavior of principals in the context of franchising. They develop an empirical model of franchising, starting with a principal agent framework that emphasizes the role of franchisees' collateral from an incentive perspective. They then estimate the determinants of chains' entry (into franchising) and growth decisions, using data on franchised chains and data on local macroeconomic conditions. In particular, they use state-level housing wealth that can be collateralized, as an inverse measure of the average financial constraints of potential franchisees. They find that a decrease in that housing wealth in the local economy leads to later entry into franchising by local franchisors and to slower growth in the number of franchised – and total – outlets in these chains. The corresponding job losses can be substantial.

Matthew Gentzkow and Jesse Shapiro, University of Chicago and NBER, and Michael Sinkinson, University of Pennsylvania

Competition and Ideological Diversity: Historical Evidence from US Newspapers (NBER Working Paper No. 18234)

Gentzkow, Shapiro, and Sinkinson use data on U.S. newspapers from the early 20th century to study the economic incentives that shape ideological diversity in the media. They show that households prefer like-minded news, and that newspapers seek to cater to household tastes and to differentiate from their competitors. The researchers estimate a model of newspaper demand, entry, and political affiliation choice in which newspapers compete for readers and for advertisers. They find that economic competition enhances ideological diversity, that the market under supplies diversity, and that incorporating the two-sidedness of the news market is critical to evaluating the effect of public policy.