Industrial Organization

February 20-21, 2015
Michael J. Dickstein of Stanford University and Ali Hortacsu, University of Chicago, Organizers
Part of the meeting was held jointly with the NBER's Insurance Program, and papers marked with a (*) were presented to the joint session.

(*)Francesco Decarolis, Boston University; Maria Polyakova, Stanford University; and Stephen P. Ryan, University of Texas, Austin and NBER

The Welfare Effects of Supply-Side Regulations in Medicare Part D

Decarolis, Polyakova, and Ryan study the efficiency of the regulatory mechanisms through which the government currently administers subsidies in Medicare Part D, a large prescription drug program for U.S. seniors. Using the data from the first four years of the program, the researchers estimate an econometric model of supply and demand that incorporates the regulatory pricing distortions in the insurers' objective functions. They have four primary results: consumers have a relatively low willingness-to-pay for stand-alone prescription drug plans when compared to drug coverage within comprehensive Medicare managed care plans; competition among insurers is fairly effective in lowering prices towards marginal cost; the primary driver of welfare in the program is the trade-off between relative subsidies and the relative willingness to pay for different parts of Medicare Part D program; and the current subsidization policy achieves a level of total welfare close to that obtained under an optimal voucher scheme, but is far from the social planner's first-best solution.

(*)Neale Mahoney, University of Chicago and NBER, and Glen Weyl, Microsoft Corporation

Imperfect Competition in Selection Markets (NBER Working Paper (NBER Working Paper 20411)

Standard policies to correct market power and selection can be misguided when these two forces co-exist. Using a calibrated model of employer-sponsored health insurance, Mahoney and Weyl show that the risk adjustment commonly used by employers to offset adverse selection often reduces the amount of high-quality coverage and thus social surplus. Conversely, in a model of subprime auto lending calibrated to Einav, Jenkins and Levin (2012), realistic levels of competition among lenders generate a significant oversupply of credit, implying greater market power is desirable. These results motivate a general model of symmetric imperfect competition in selection markets that parameterizes the degree of both market power and selection. The researchers use graphical price-theoretic reasoning to comprehensively characterize the interaction between selection and imperfect competition. Their results imply that in selection markets four principles of the United States Horizontal Merger Guidelines are often reversed.

(*)Elisabeth Honka, University of Texas, Dallas, and Pradeep Chintagunta, University of Chicago

Simultaneous or Sequential? Search Strategies in the U.S. Auto Insurance Industry

Honka and Chintagunta show that the search method consumers use when resolving uncertainty in the prices of alternatives is identified in data where consumers' consideration sets (but not sequence of searches), prices for the considered alternatives and market-wide price distributions are observed. The search method is non-parametrically identified by different patterns of actual prices in consumers' consideration sets across search methods. The authors also provide a new estimation approach for the sequential search model; complementing earlier work that has estimated a simultaneous search model with such data. Using a novel data set on consumer shopping behavior in the U.S. auto insurance industry that contains information on consideration sets and choices, they find that the pattern of actual prices in consumers' consideration sets are consistent with consumers searching simultaneously. Their counterfactuals show that the largest insurance companies are better off in terms of market share when consumers search sequentially, while smaller companies benefit from consumers searching simultaneously. The results regarding the composition of the customer base are mixed. As the search method affects consumers' consideration sets, which in turn influence brand choices, understanding the nature of consumer search and its implications for consideration and choice is important from a managerial perspective.

Gregory Crawford and Nicola Pavanini, University of Zurich, and Fabiano Schivardi, LUISS University and EIEF

Asymmetric Information and Imperfect Competition in Lending Markets

Crawford, Pavanini, and Schivardi measure the consequences of asymmetric information and imperfect competition in the Italian market for small business lines of credit. They provide evidence that a bank's optimal price response to an increase in adverse selection varies depending on the degree of competition in its local market. More adverse selection causes prices to increase in competitive markets, but can have the opposite effect in more concentrated ones, where banks trade off higher markups and the desire to attract safer borrowers. This implies both that imperfect competition can moderate the welfare losses from an increase in adverse selection, and that an increase in adverse selection can moderate the welfare losses from market power. Exploiting detailed data on a representative sample of Italian firms, the population of medium and large Italian banks, individual lines of credit between them, and subsequent defaults, the authors estimate models of demand for credit, loan pricing, loan use, and firm default to measure the extent and consequences of asymmetric information in this market. While their data includes a measure of observable credit risk available to a bank during the application process, the researchers allow firms to have private information about the underlying riskiness of their project. This riskiness influences banks' pricing of loans as higher interest rates attract a riskier pool of borrowers, increasing aggregate default probabilities. The authors find evidence of adverse selection in the data, and increase it with a policy experiment to evaluate its importance. As predicted in the counterfactual equilibrium, prices rise in more competitive markets and decline in more concentrated ones, where the authors also observe an increase in access to credit and a reduction in default rates. Thus market power may serve as a shield against the negative effects of an increase in adverse selection.

Pedro Gardete, Harikesh Nair, and Anna Tuchman, Stanford University

Complementarities in Consumption and the Consumer Demand for Advertising

The standard paradigm in the empirical literature is to treat consumers as passive recipients of advertising, with the level of ad exposure determined by firms' targeting technology and the intensity of advertising supplied in the market. This paradigm ignores the fact that consumers may actively choose their consumption of advertising. Endogenous consumption of advertising is common. Consumers can easily choose to change channels to avoid TV ads, click away from paid online video ads, or discard direct mail without reading advertised details. Becker and Murphy (1993) recognized this aspect of demand for advertising and argued that advertising should be treated as a good in consumers' utility functions, thereby effectively creating a role for consumer choice over advertising consumption. They argued that in many cases demand for advertising and demand for products may be linked by complementarities in joint consumption. Tuchman, Nair, and Gardete leverage access to an unusually rich dataset that links the TV ad consumption behavior of a panel of consumers with their product choice behavior over a long time horizon to measure the co-determination of demand for products and ads. The data suggests an active role for consumer choice of ads, and for complementarities in joint demand. To interpret the patterns in the data, the researchers fit a structural model for both products and advertising consumption that allows for such complementarities. They explain how complementarities are identified. Interpreting the data through the lens of the model enables a precise characterization of the treatment effect of advertising under such endogenous non-compliance, and assessments of the value of targeting advertising. To illustrate the value of the model, the authors compare advertising, prices and consumer welfare to a series of counterfactual scenarios motivated by the "addressable" future of TV ad-markets in which targeting advertising and prices on the basis of ad-viewing and product purchase behavior is possible. They find that both profits and net consumer welfare can increase, suggesting that it may be possible that both firms and consumers are better off in the new addressable TV environments. They believe their analysis holds implications for interpreting ad-effects in empirical work generally, and for the assessment of ad-effectiveness in many market settings.

Michael Sinkinson, University of Pennsylvania, and Amanda Starc, University of Pennsylvania and NBER

Ask Your Doctor? Direct-to-Consumer Advertising of Pharmaceuticals

Sinkinson and Starc measure the impact of direct-to-consumer television advertising by statin manufacturers. Their identification strategy exploits shocks to local advertising markets generated by idiosyncrasies of the political advertising cycle. The authors find that a 10% increase in the quantity of a firm's advertising leads to a 0.76% increase in revenue, while the same increase in rival advertising leads to a 0.55% decrease in firm revenue. Results also indicate that a 10% increase in category advertising produces a 0.2% revenue increase for non-advertised drugs. Both the business-stealing and spillover effects would not be detected through OLS. Decomposition using micro data comfirms that the effect is due mostly to new customers as opposed to switching among current customers. Simulations show that an outright ban on DTCA would have modest effects on the sales of advertised drugs as well as on non-advertised drugs.

Nikhil Agarwal and Paulo J. Somaini, MIT and NBER

Demand Analysis Using Strategic Reports: An Application to a School Choice Mechanism (NBER Working Paper (NBER Working Paper 20775)

Several school districts use assignment systems in which students have a strategic incentive to misrepresent their preferences. Indeed, Agarwal and Somaini find evidence suggesting that reported preferences in Cambridge, MA respond to these incentives. Such strategizing can complicate the analysis of preferences. The paper develops a new method for estimating preferences in such environments. Their approach views the report made by a student as a choice of a probability distribution over assignment to various schools. The authors introduce a large class of mechanisms for which consistent estimation is feasible. They then study identification of a latent utility preference model under the assumption that agents play a Bayesian Nash Equilibrium. Preferences are non-parametrically identified under either sufficient variation in choice environments or sufficient variation in a special regressor. The researchers then propose a tractable estimation procedure for a parametric model based on Gibbs’ sampling. Estimates from Cambridge suggest that while 84% of students are assigned to their stated first choice, only 75% are assigned to their true first choice. The difference occurs because students avoid ranking competitive schools in favor of less competitive schools. Although the Cambridge mechanism is manipulable, the authors estimate that welfare for the average student would be lower in the popular Deferred Acceptance mechanism.

Christina M. Dalton, Wake Forest University; Gautam Gowrisankaran, University of Arizona and NBER; and Robert Town, University of Pennsylvania and NBER

Myopia and Complex Dynamic Incentives: Evidence from Medicare Part D

Under the standard benefit package, Medicare Part D drug coverage provides no coverage in a "donut hole" region, which makes the purchase problem dynamic. Dalton, Gowrisankaran, and Town specify a dynamic drug purchase model with hyperbolic discounting. They develop a regression discontinuity based test for myopia, using a sample of enrollees who arrived near the coverage gap early in the year and hence who should rationally expect to reach it. They find that that purchases are flat before the gap but that there are fewer and cheaper purchases immediately after reaching the gap, providing evidence of myopia. The researchers structurally estimate the dynamic model using maximum likelihood. They find that, for the full sample of Part D enrollees, behavioral hazard increases enrollee spending by 44%. A counterfactual policy that closed the coverage gap in a revenue-neutral way would require 42% coinsurance.

Gregory Crawford, University of Zurich; Robin S. Lee, Harvard University and NBER; Ali Yurukoglu, Stanford University and NBER, and Michael D. Whinston, MIT and NBER

The Welfare Effects of Vertical Integration in Multichannel Television

Crawford, Lee, Yurukoglu, and Whinston investigate the welfare effects of vertical integration of regional sports networks (RSNs) in U.S. multichannel television markets. Vertical integration can enhance efficiency by reducing double marginalization and increasing carriage of these channels, but can also harm welfare due to foreclosure and raising rivals' costs incentives. The researchers estimate a structural model of viewership, subscription, distributor pricing, and affiliate fee bargaining using a rich dataset on the U.S. cable and satellite television industry (2000-2010). The authors use these estimates to analyze the impact of simulated vertical mergers and de-mergers of RSNs by distributors on competition and welfare, and examine the efficacy of regulatory policy introduced in the 1992 Cable Act by the U.S. Federal Communications Commission.

Jean-Pierre H. Dubé, University of Chicago and NBER; Zheng Fang, Sichuan University; and Xueming Luo, Temple University

Self-Signaling and Pro-Social Behavior: a cause marketing mobile field experiment

Dubé, Luo, and Fang test a self-signaling theory using two large-scale, randomized controlled field experiments. Mobile phone users are randomly sampled to receive promotional offers for movie tickets via SMS technology. Test groups are exposed to different pre-determined levels of price discounts and charitable donations tied to the ticket purchase. The main effects of price discounts and charitable donations increase ticket demand. However, the combination of both discounts and donations can decrease ticket demand. In a post-purchase survey, the same subjects self-report lower ratings of "feeling good about themselves" as the motivation for buying a ticket when discounts and donations are both large. These findings are consistent with a self-signaling theory, whereby the discount crowds out the consumer's "warm-glow" feeling from the charitable donation. Alternative behavioral explanations are ruled out. A structural model of demand with self-signaling is fit to the data using a constrained optimization algorithm to handle the potential multiplicity of equilibria. The estimated preferences reveal that consumers do not derive consumption utility from donations bundled with the ticket. However, they derive significant diagnostic utility: the warm-glow feeling of the self-perception of valuing charitable donations.

Daniel Björkegren, Brown University

The Adoption of Network Goods: Evidence from the Spread of Mobile Phones in Rwanda

This paper develops a method to estimate and simulate the adoption of a network good. Björkegren estimates demand for mobile phones as a function of individuals' social networks, coverage, and prices, using transaction data from nearly the entire network of Rwandan mobile phone subscribers over 4.5 years. Because subscribers pay on the margin for calls, the calls placed reveal the value of communicating with each contact. This feature allows the author to overcome traditional difficulties in measuring network effects, by estimating the utility of adopting a phone based on its eventual usage. Björkegren uses this structural model to simulate the effects of two governmental policies. An adoption subsidy had a high social rate of return, and spillovers accounted for a substantial fraction of its impact. A requirement to serve rural areas lowered the operator's profits but increased net social welfare. Benefits from this policy were widely dispersed, with the majority accruing to individuals in areas where coverage was not affected.