Industrial Organization

February 20-21, 2009
Matthew Gentzkow and Matthew White, Organizers
Nancy Rose, Program Director

Justine Hastings, Yale University and NBER
Wholesale Price Discrimination and Regulation: Implications for Retail Gasoline Prices

Nuno Cassola, European Central Bank, Ali Hortaçsu, University of Chicago and NBER, and Jakub Kastl, Stanford University
The 2007 Subprime Market Crisis in the EURO Area through the Lens of ECB Repo Auctions

Cassola, Hortaçsu, and Kastl study the sudden change in bidding behavior in primary auctions of liquidity that were run by the European Central Bank in August 2007after the subprime market crisis spilled over to the Euro area. A direct analysis of changes in the bidding patterns suggests that virtually all banks suffered from a decrease in access to liquidity in the secondary markets and thus started bidding more aggressively in the primary market. Using an estimated model of bidding in these auctions, the authors find that for about one third of participants this change in bidding behavior was simply a strategic response. For the other two-thirds this change was indeed spurred by an increase in their values for liquidity obtained in the primary market. The change in values likely occurred either because of an exposure of some banks to risky asset-backed securities -- which required a substantial risk premium or could not be used as collateral in the interbank-liquidity market -- or because of increased uncertainty about future liquidity needs. Both of these effects in turn caused the primary market to be a comparatively cheaper and more certain source of liquidity. The researchers also show that the primary auctions of liquidity may have played an important role in improving the efficiency of the allocation when the secondary markets failed to serve this role. Using a smaller complementary dataset, they further analyze the changes in private values using data which probably was part of the private information set of each bank when submitting its bid.

Liran Einav, Stanford University and NBER ;Amy Finkelstein, MIT and NBER, and Mark Cullen, Yale University
Estimating Welfare in Insurance Markets using Variation in Prices

Einav, Finkelstein, and Cullen show how standard consumer and producer theory can be used to estimate welfare in insurance markets with selection. Their key observation is that the price variation needed to identify the demand curve also identifies the way that costs vary as market participants endogenously respond to price. With estimates of both the demand and cost curves, the welfare analysis is straightforward. The authors illustrate their approach by applying it to the employee health insurance choices at Alcoa, Inc. They detect adverse selection in this setting, but estimate that its quantitative welfare implications are small, and not obviously remediable by standard public policy tools.

Jean-Pierre Dubé and Jeremy Fox, University of Chicago and NBER and Che-Lin Su, University of Chicago
Improving the Numerical Performance of BLP Static and Dynamic Discrete Choice Random Coefficients Demand Estimation

Dubé, Fox, and Su provide numerical results that characterize the properties of typical nested-fixed-point (NFP) implementations. They use these results to discuss several problems with typical computational implementations and, in particular, cases which can lead to incorrect parameter estimates. As a solution, they recast estima¬tion as a mathematical program with equilibrium constraints (MPEC). In some instances, MPEC is faster than alternative approaches. It also avoids the numerical issues associated with nested inner loops. Several Monte Carlo and real-data experiments support their numerical concerns about NFP and the advantages of MPEC. They also discuss estimating static BLP using maximum likelihood instead of GMM. Finally, they show that MPEC is particularly attractive for forward-looking demand models where both Bellman’s equation and the market share equations must be solved repeatedly.

Andrew Sweeting, Duke University and NBER
Equilibrium Price Dynamics in Perishable Goods Markets: The Case of Secondary Markets for Major League Baseball Tickets

Sweeting analyzes the dynamics of prices in two online secondary markets for Major League Baseball tickets. Controlling for ticket quality, the prices tend to decline significantly as a game approaches. The paper describes and tests alternative theoretical explanations for why this happens in equilibrium, considering the problems of both buyers and sellers. It shows that sellers cut prices (either fixed prices or reserve prices in auctions) because of declining opportunity costs of holding onto tickets as their future selling opportunities disappear. Even though prices can be expected to fall, the majority of observed early purchases can be rationalized by plausible ticket valuations and return to market costs given product differentiation and uncertainties about ticket availability.

Patrick Bajari, University of Minnesota and NBER and Gregory Lewis, Harvard University
Procurement Contracting with Time Incentives: Theory and Evidence

In public sector procurement, social welfare often depends on how long it takes to complete the contract. A leading example is highway construction, where slow completion times inflict a negative externality on commuters. In standard highway contracts, contractors pay only a small penalty for late project completion. As a result, contractors do not fully internalize the negative externality of delays, resulting in welfare losses compared to an efficient allocation. Recently, state highway departments introduced an innovative contracting method called A+B bidding to reduce this inefficiency, where contractors bid on project completion time in addition to total project cost. Bajari and Lewis compare these two market designs theoretically and empirically. They characterize equilibrium bidding and efficient design, showing that A+B contracts can achieve the social optimum. They then gather a unique dataset of highway repair projects awarded by the Minnesota Department of Transportation which include both contract forms. Their descriptive empirical analysis suggests that observed behavior is broadly consistent with the predictions of their theoretical model. Next they build a structural econometric model that endogenizes project completion times. Their estimates suggest that switching from standard contracts to designs with socially efficient time incentives could increase welfare by over 32 percent of the contract value on average. They conclude that large improvements in social welfare are possible through the use of improved auction design.

Megan Busse, Northwestern University and NBER, Christopher Knittel, UC, Davis and NBER,and Florian Zettelmeyer, Northwestern University and NBER
Pain at the Pump: How Gasoline Prices Affect Automobile Purchasing in New and Used Markets

Busse and her co-authors investigate how gasoline prices affect equilibrium prices and market shares for cars of different fuel efficiencies in both the new and used car markets. They find that, in general, when gasoline prices increase, prices fall and market shares decrease for fuel-inefficient cars, and the reverse holds for fuel-efficient cars. However, the relative magnitudes of these effects differ dramatically between the new and used car markets: in the new car market, the adjustment is primarily in market shares, while in the used car market, the adjustment is primarily in prices. The authors explore reasons for these differences between the markets.

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