Raise Consumer Surplus Research Articles

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).

Artificial intelligence adoption in a competitive market

AbstractEconomists have often viewed the adoption of artificial intelligence (AI) as a standard process innovation where we expect that efficiency will drive adoption in competitive markets. This paper models AI based on recent advances in machine learning that allow firms to engage in better prediction. Focusing on prediction of demand, it is demonstrated that AI adoption is a complement to variable inputs whose levels are altered directly by predictions and whose use is economized by them (that is, labour). It is shown that in a competitive market, this increases the short‐run elasticity of supply and may or may not increase average equilibrium prices. Generically, there are externalities in adoption, with this reducing the profits of non‐adoptees when variable inputs are important, and increasing them otherwise. Thus AI does not operate as a standard process innovation, and its adoption may confer positive externalities on non‐adopting firms. In the long run, AI adoption is shown to lower prices generally and raise consumer surplus in competitive markets.

Efficiency-Enhancing Horizontal Mergers in Spatial Competition with Network Externalities

We study horizontal mergers in a network products market with a three-firm model of spatial competition, where two merged firms become compatible at the expense of product differentiation. We consider two different approaches to modeling rational expectations: responsive and passive. The results show that the merger may reduce industry competition, since the merger-related compatibility enlarges the network scales for insiders and amplifies product differentiation between the insiders and the outsider; therefore, the proposed merger may benefit all firms, raise consumer surplus, and enhance social welfare, i.e., the merger is Pareto-improving.

Personalized pricing with a price sensitive demand

This paper assesses the profit and welfare effects of firms’ ability to charge personalized prices in markets where consumer demand is sensitive to price changes. In a mill pricing model, regardless of demand elasticity, personalized pricing (PP) raises consumer surplus at the expense of profits. In contrast, in a delivered pricing model, if demand is sufficiently elastic, PP boosts profits at the expense of consumer surplus and overall welfare. Moving from PP in a mill to a delivered pricing model, benefits industry profits and harms consumer surplus and welfare.

Revenge consumption, government‐led voucher, and social welfare

This paper considers revenge consumption and government vouchers directly provided to the consumers in a duopoly model of vertical product differentiation. We find that revenge consumption will raise consumer surplus and social welfare. The government issuing vouchers will further push up consumer surplus and social welfare; however, facing the wave of revenge consumption, the government purposely want to recover the slowdown economy caused by the pandemic spread-out, should fully consider the quality difference of products and issue different discount rate voucher. For the producer, whether the government issuing vouchers increase firm's profit depends on the degree of revenge consumption and product differentiation.

Multiproduct mergers and quality competition

AbstractWe investigate mergers in markets where quality differences between products are central and firms may reposition their product lines by adding or removing products of different qualities following a merger. Such mergers are materially different from those studied in the existing literature. Mergers without synergies may exhibit a product‐mix effect which raises consumer surplus, but only when the pre‐merger industry structure satisfies certain observable features. Post‐merger synergies may lower consumer surplus. The level of, and changes in, the Herfindahl–Hirschman Index may give a misleading assessment of how a merger affects consumers. A merger may benefit some outsiders but harm others.

Quality choice and behavior-based price discrimination

This study examines the impacts of behavior-based price discrimination (BBPD) on profits, consumer surplus, and welfare when firms choose their product qualities. To this end, we consider a differentiated duopoly model in which firms first make quality decisions, and in the two subsequent periods, compete in prices according to the pricing scheme, namely, uniform pricing or BBPD. We show that when consumers are more than moderately forward-looking, firms choose lower quality levels under BBPD than under uniform pricing. The profit and consumer surplus effects of BBPD relative to uniform pricing depend on the level of consumers’ myopia and/or quality improvement costs. When consumers are sufficiently myopic or quality costs are high, BBPD reduces industry profits and raises consumer surplus. However, the reverse happens when consumers are sufficiently forward-looking and quality costs are low. Interestingly, BBPD is detrimental to both firms and consumers when consumers are sufficiently forward-looking and quality costs are moderate, or when consumers are moderately forward-looking and quality costs are low. Social welfare is always lower under BBPD than under uniform pricing.

Multi-Sided Platform Strategy, Taxation, and Regulation: A Quantitative Model and Application to Facebook

Digital platforms such as Facebook create value by connecting users, vendors, and contractors. Their strong supply and demand economies of scale can give them market power, and have led to increasing calls for special regulations and taxes. We construct and illustrate an approach for structural modeling of digital platforms. The model allows for heterogeneity in demand elasticity, disutility from advertising, and network effects across users. We paramaterize our model using a survey of over 57,000 US internet users on their demand for Facebook's eponymous application. Facebook creates $14 billion in social value per month, with consumer surplus concentrated among female and older users of Facebook. The most valuable friendships on Facebook are worth in excess of 50 cents per month, but most are worth far less, with connections to men more valuable on a per-friend basis. We find that Facebook has too low a level of advertising relative to their short-term profit maximizing strategy. Imputing their shadow value from maintaining a large user base, we estimate that the welfare lost from Facebook's market power, compared to the first best of a social welfare maximizing Facebook, is 9.6% of current social value, or $1.3 Billion per month. We then simulate six proposed policies for government management of digital platforms, taking Facebook's optimal response into account. Taxes are mostly incident on Facebook profit and properly targeted taxes can even raise consumer surplus. Achieving perfect competition in social media would raise social surplus from Facebook by 4.8% of current value. But a botched regulation that left the US with two smaller, non-competitive social media monopolies would decrease social surplus by 84.7%.

Platform Design When Sellers Use Pricing Algorithms

Using both economic theory and Artificial Intelligence (AI) pricing algorithms, we investigate the ability of a platform to design its marketplace to promote competition, improve consumer surplus, and even raise its own profits. We allow sellers to use Q-learning algorithms (a common reinforcement-learning technique from the computer-science literature) to devise pricing strategies in a setting with repeated interactions, and consider the effect of platform rules that reward firms that cut prices with additional exposure to consumers. Overall, the evidence from our experiments suggests that platform design decisions can meaningfully benefit consumers even when algorithmic collusion might otherwise emerge but that achieving these gains may require more than the simplest steering policies when algorithms value the future highly. We also find that policies that raise consumer surplus can raise the profits of the platform, depending on the platform's revenue model. Finally, we document several learning challenges faced by the algorithms.

Multiproduct Mergers and Quality Competition

We investigate mergers in markets where quality differences between products are central and firms may reposition their product lines by adding or removing products of different qualities following a merger. Such mergers are materially different from those studied in the existing literature. Mergers without synergies may exhibit a product-mix effect which raises consumer surplus, but only when the pre-merger industry structure satisfies certain observable features. Post-merger synergies may lower consumer surplus. The level of, and changes in, the Herfindahl-Hirschman Index may give a misleading assessment of how a merger affects consumers. A merger may benefit some outsiders but harm others.

Regulating monopoly price discrimination

A monopolist sells its product in separated markets. The effects of requiring a uniform profit margin instead of monopoly pricing are assessed. A margin equal to the output-weighted arithmetic mean of the monopoly margins raises consumer surplus but reduces total output. When the margin equals the (lower) harmonic mean total output exceeds the monopoly level if the demand functions are convex, and social welfare rises. Extensions cover a uniform price-marginal cost ratio and a uniform margin when the initial price is uniform and costs differ. The analysis uses convexity relations and the implications of profit-maximization.

Mixed duopoly with foreign firm and subcontracting

We consider a Hotelling model, in which a public firm competes with a foreign firm, at the mean time cooperates with it through subcontracting. We find that when there exists subcontracting, the presence of a foreign firm raises social welfare. Comparing to competing with the domestic private firm, when the public firm competes with the foreign firm, social welfare is lower, but consumer welfare is higher. And a variation in firms’ costs or tariffs has no effect on either firm's location. Tariff on inputs raises domestic social welfare and government will charge an input tariff to the extent of costs difference. Tariff on final good has no effect on welfare but will raise prices and thus hurt consumers. Compared to no tariff at all, tariff on inputs alone raises retail prices, but tariffs on both inputs and final goods may reduce prices and raise consumer surplus.

Credence Goods, Misleading Labels, and Quality Differentiation

Due to differences in information disclosure mechanisms, consumer misinformation about the quality of many credence goods is more endemic at intermediate levels of the quality spectrum rather than at the extremes. Using an oligopoly model of vertical product differentiation, we examine how consumers’ overestimation of the quality of intermediate-quality products affects firms’ incentives to improve product quality. The firms non-cooperatively choose the quality of their product before choosing its price or quantity. Irrespective of the nature of second stage competition, Bertrand or Cournot, we find that quality overestimation by consumers increases profit of the intermediate-quality firm, and motivates it to raise its product’s quality. In response, the high-quality firm improves its product quality even further but ends up with lower profit. Overall, average quality of the vertically differentiated product improves, which raises consumer surplus. Social welfare increases when the firms compete in prices but falls when they compete in quantities.

Bundling, à la carte pricing and vertical bargaining in a two-sided model

We develop a two-sided market model with an upstream–downstream structure. More specifically, the platform consists of two rival upstream firms and a downstream monopolist. Each upstream firm negotiates the input price (license fee) with the downstream monopolist and also chooses the amount of advertising that is embedded in the good it sells to the downstream monopolist. The downstream monopolist can offer the two goods either on an à la carte basis or as a bundle. We use this model to understand the incentives to bundle and the welfare properties of bundling in a two-sided market framework. We also contribute to the ongoing debate on à la carte pricing in the TV industry, where the two upstream firms can be viewed as two rival TV networks and the downstream monopolist as a cable operator. We show that an à la carte regulation will raise consumer surplus and downstream profit, while it will decrease the profits of the upstream TV networks.

Decreasing Returns, Patent Licensing and Price-Reducing Taxes

In industries where a patent system is in place, licensing agreements among competing firms often create distortions, as they involve royalties. Royalties are generally considered to be anti-competitive as they raise market prices and reduce consumer welfare. In this paper we propose simple tax policies that can alleviate these effects. We consider industries where firms produce under decreasing returns and trade a patented technology. We first show that the interaction of royalty rates with decreasing returns can generate the counter-intuitive result that market prices decrease in the magnitude of diseconomies of scale. Using this result, we construct quantity tax schemes that lower prices and raise consumer surplus. Via these taxes the government collects sufficient revenue to compensate firms for their losses, without incurring any public deficit. Thus our schemes strictly Pareto improve the welfare of all agents.

Mixed Duopoly with Foreign Firm and Subcontracting

We consider a Hotelling model, in which a public firm competes with a foreign firm, at the mean time cooperates with it through subcontracting. We find that when there exists subcontracting, the presence of a foreign firm raises social welfare. Comparing to competing with the domestic private firm, when the public firm competing with the foreign firm, social welfare is lower, but consumer welfare is higher. And a variation in firms' costs or tariffs has no effect on either firm's location. Tariff on inputs raises domestic social welfare and government will charge an input tariff to the extent of costs difference. Tariff on final good has no effect on welfare but will raise prices and thus hurts consumers. Compared to no tariff at all, tariff on inputs alone raises retail prices, but tariffs on both inputs and final goods may reduce prices and raise consumer surplus.

Consumer-surplus-enhancing collusion and trade

That collusion among sellers hurts buyers is a central tenet in economics. We provide an oligopoly model in which collusion can raise consumer surplus. A differentiated-product duopoly operates in two geographically separated markets. Each market is home to a single firm, but can import, at a cost, from the foreign firm. Under some circumstances, a perfect cartel, relative to duopolistic competition, raises the price of the imported good and lowers the price of the home good. This raises welfare for most consumers and increases aggregate consumer surplus. A similar possibility result applies to autarky. Our analysis applies beyond the spatial setting.

Post-Merger Bundling in the Cable Industry: The Case of Time Warner and Turner Broadcasting

The cable industry consists of both upstream and downstream firms: the Cable Television Programming Service Providers (CTPSPs) and the Multichannel Service Operators (MSOs). The CTPSPs create and provide basic cable programming to MSOs in exchange for monthly per-subscriber fees; they also receive funding from advertisers ( JRANK Encyclopedia). MSOs purchase franchise rights to operate in specific regions, where they act as monopoly providers of cable,* providing subscribers with their choice of programming bundle for a monthly fee. In this paper, I look at the effects upstream bundling may have on subscribers. Gregory Crawford shows that downstream bundling of highly soughtafter programming lowers subscriber surplus but raises profits for the cable providers (Crawford 2006). However, a model allowing for differentiated consumer preferences reveals that the price-discriminatory effects of bundling† may in fact raise consumer surplus. Indeed, while Michael Whinston emphasizes that bundling independent goods is an effective and profitable means for deterring entry (Whinston 1990), my model points to a somewhat counterintuitive outcome: product bundling can, at times, facilitate market entry by competitors and improve the welfare of consumers. My approach supports

Price-Matching, Quality Free-Riding and Predation

This paper investigates the roles of price-matching guarantee as a response to `showrooming' (quality free-riding) and as a tool for predation. Employing a duopoly vertical differentiation model, we find that price-matching guarantee raises consumer surplus but its impact on social surplus is ambiguous. We identify two effects of price-matching guarantee on firms' profits. The change of sales effect improves the high quality firm's profit at the cost of its low quality rival while the intensified competition effect reduces both firms' profits. When the level of quality free-riding is sufficiently high, the change of sales effect dominates and price-matching guarantee raises the high quality firm's profit. On the other hand, when the level of quality free-riding is low, a price-matching guarantee lowers both firms' profits, suggesting a possible anti-trust rationale if adopted. That is, the high quality firm adopts a price-matching guarantee to drive the low quality firm out of market (predation through price-matching).

Bundling, A La Carte Pricing and Vertical Bargaining in a Two-Sided Model

We develop a two-sided market model with an upstream-downstream structure. More specifically, the platform consists of two rival upstream firms and a downstream monopolist. Each upstream firm negotiates the input price (license fee) with the downstream monopolist and also chooses the amount of advertising that is embedded in the good it sells to the downstream monopolist. The downstream monopolist can offer the two goods either on an a la carte basis or as a bundle. We use this model to understand the incentives to bundle and the welfare properties of bundling in a two-sided market framework. We also contribute to the ongoing debate on a la carte pricing in the TV industry, where the two upstream firms can be viewed as two rival TV networks and the downstream monopolist as a cable operator. We show that an a la carte regulation will raise consumer surplus and downstream profit, while it will decrease the profits of the upstream TV networks.