The iPhone must have an exclusive carrier

Aren't you angry that the particular mobile phone you prefer has an exclusive contract with a carrier? This limitation of carrier choice seems anti-competitive, if not frustrating. US anti-trust authorities seem to be getting interested in these arrangements and may intervene. It turns out that maybe they should not.

Robert Hahn and Hal Singer say exclusivity contracts are in fact the best thing that could happen for consumer welfare. Indeed, they spur competition through innovation, and the fact that the smart phone industry is innovative is hardly an understatement. Indeed, the exclusive contracts allow manufacturers to share the risk with the carrier, they make sure that both want the success of the new phone, and thus insure better reception and coverage. All this taken together induces manufacturers to take more risk and go for even faster and bolder innovations, which ultimately benefits the consumer.

Less competition is good for insurance

Competition is best, economists often claim. Except when it is not, for example in the case of natural monopolies, where the duplication of infrastructure is wasteful. THe case can also be made that competition is not as good as one would think in the insurance industry

Giuseppe de Feo and Jean Hindriks explain that adverse selection has worse consequences under competition. Indeed, in a monopoly, the insurance company can make profits on some products which allows to cross-subsidize others. With competition. profits are driven to a minimum, and cross-subsidization is minimal. This is important because cross-subsidies allows to relax the incentive constraint. This provides better coverage for high risks, but lowers participation among low risks.

One aspect that was not mentioned in the paper is that monopolistic insurers, because they have a larger market share, are better able to diversify the individual risk of the insureds. Observationally, this makes them closer to risk-neutral, and thus allows them to offer lower premiums, every else being equal. Of course, they could use their monopoly power to raise premiums, but with smart regulation or threats to entry, this can be prevented and the full social benefit can be obtained.

Price discrimination drives industry leaders to further innovate

Quality-ladder models in the innovation literature describe how firms try to outdo each other in research and development in order to become market leaders by producing the most advanced products. One log-standing result of this literature is that leaders have no incentives to innovate because it would cannibalize their own business, a result that flies in the face of overwhelming evidence to the contrary.

Hélène Latzer builds a model where firms can price discriminate in a specific market. The difference with standard quality ladder models is that consumers differ by wealth, preferences are non-homothetic and only full units of technology goods can be consumed. In standard models, it is always winner-takes-all. Here, because a slightly obsolote product still has a market, a market leader may still want to innovate to capture also the market for the second-best good.

When ad avoidance backfires

Now that there is technology to avoid ads on television, advertisers are willing to pay less to air their announcements. What consequences would such a loss of revenue have on the television landscape?

Torben Stuehmeier and Tobias Wenzel say that the reduced profit opportunities should reduce entry (or favor exit) from the free-to-air television market. Note, however, that those how avoid ads are those who are bothered by them. The remainder are those the advertisers want to reach, so ads may become more numerous. In contrast, pay-TV (either pay-to-subscribe or pay-per-view) should be able to charge more for subscriptions to compensate for the reduced ad income. There is no change in revenue.

Thinking about welfare, the TiVo customers have the same utility as they pay for their subscription what they think ad avoidance is worth. But for everyone, there are now fewer channels to chose from the free-to-air market and consumers are worse off. In a pay-TV market, welfare is also reduced, as non-users pay more for subscriptions. Now extend the model of Stuehmeier and Wenzel to allow both television industries to co-exist and compete against each other. As customers have fewer free options, they will go towards the pay channels. The end result: a similar number of channels, but more you have to pay for. Consumer welfare was reduced by the availability of the TiVo box.

Note that the authors have a different concept of welfare than me. They consider not only the consumer surplus, but also television industry profits. Why would one want to consider the latter? If the argument is that it increases the income and thus the consumption of someone, why not model it explicitly? And given that the only good produced in this model is differentiated television channels (with a bad through ads), that is all what counts. Profits are just a monetary illusion here.

Open platforms versus cartels in professional sports leagues

What makes a sports league more competitive? More interesting? And more profitable? We have two basic models out there. The European model, with open entry, promotion and relegation on mostly athletic grounds, and the American model, a cartel with regulated entry and no exit except on economic grounds. Basic economics should tell us that an American league should be more profitable but of lesser athletic quality, while the European one should be providing more value, both in terms of quantity and the quality of the good (say, athleticism and entertainment).

Helmut Dietl and Tobias Duschl confirm this conjecture. Indeed, the six top revenue generating teams are European, but some of them are still not profitable, and as in the case of Manchester United, despite significant athletic success. Dietl and Duschl use platform organization, a form of two-sided market theory, to get some better understanding of sports league organizations. In this regard, European leagues can be compared to open source like Linux, open and performing, while American leagues are like Windows, underperforming but most profitable.

Table 2 from the paper summarizes well the differences between the leagues. In European ones, most clubs are members' associations that try to maximize wins. Leagues are open (promotion/relegation), there is full market coverage, hardly any relocations (I cannot think of one), and no salary caps. As a consequence, value (as defined by athleticism or entertainment) is maximized. Contrast this with American leagues, where clubs are privately owned and maximize profits. League are closed, there is rationing, frequent relocation and a salary cap. Thus, American leagues maximize value appropriation.

Advertising and GDP

How does advertising contribute to social welfare? It raises the awareness about products, and thus should increase utility of people. But there is also some waste of resources when competitors outdo each other with advertising. Think for example of all the resources devoted by Coca-Cola and Pepsi to sway user between two essentially identical products. So, in the end, is advertising good or bad?

Benedetto Molinari and Francesco Turino point to a positive correlation between GDP and advertising in the OECD and try to rationalize this within the Neoclassical growth model. They find that the impact of advertising is rather through the labor supply. As individuals want to consume more, they need to work more to generate the necessary income. This increases GDP (8% for the US) and utility. And as advertising itself amounts to about 2% of GDP in the US, the net contribution to GDP remains strongly positive, at least at current levels.

Do big boxes displace mom-and-pop stores?

When Wal-Mart moves into town, is this good or bad? It is commonly perceived that this is bad for local businesses, and especially for small "mom-and-pop" stores. In reality, that depends on whether big-box stores like Wal-Mart are complements or substitutes. Intuitively, they should be largely substitutes with respect to the shops they directly compete with, while there may be complementarities with other shops as they attract more customers to town.

John Haltiwanger, Ron Jarmin and C.J. Krizan confirm this intuition. Surprisingly, this was not a clear result from the previous literature. The difference here is that establishment level data is used, and that employment dynamics within a metropolitan area are studied.

That being said, what is so bad about seeing mom-and-pop stores closing? These are high inefficient retailers, and if similar retailing services can be provided at lower cost, we should go for it. If people value a different retailing experience, they should be willing to pay for it, and visibly they are not. Banning big boxes only provides rents to existing inefficient businesses.

Open source and private firms can coexist

Open source is a mystery to many, given that contributors give away their innovations and competitors can just scoop them up. One would thus think that an industry would either be proprietary or open source, but not both at the same time.

Gastón Llanes and Ramiro de Elejalde show that it is possible. The critical features are that the open and proprietary goods not be perfect substitutes and that open source firms need to sell for a price a complementary good to the open one. That does not seem to be very constraining, as they need this anyway to survive, even without competition from proprietary goods. A perfect example for this is the database management industry, where the free MySQL is doing very well despite Oracle and Microsoft SQL.

One consequence of this is that some industry associations that like to pretend they represent the whole industry should stop chasing those that support an open source model. The music industry seems to be a perfect example here.

The proper way to create education vouchers

Education vouchers are supposed to create competition among schools to improve the level of education within a school district. In particular, it is supposed to help students get out of particularly bad schools and into better ones. The reality is, however, quite different. The best schools get even better because they can afford to become more choosy, and the differences across schools become even larger. So how could this be fixed?

Dennis Epple and Richard Romano suggest that school voucher should not be just blank checks. You need to be subtle. If you want to achieve high and equal quality education, the amount of the voucher needs to decrease with student ability, and the school need to accept them as full tuition. This requires large vouchers, and thus high taxes to finance them. Epple and Romano show that a less expensive system is possible, all you need is attach various constraints to the use and amount of the voucher. And this still works if students or schools can choose to opt out.

The key to all this is to prevent schools from making too much profit from vouchers. Essentially, vouchers increase the paying capacity of schooling demand, and schools exploit this. To counteract this, they need to be constrained, either by disallowing them to accept payments in addition to the voucher (or they would just charge the usual tuition plus voucher and laugh all the way to the bank), or allow side payments with more strings attached. The former seems much easier to implement and monitor, though. Also critical is that voucher amounts should not depend on the income or wealth of parents. Then, one can prevent richer schools from getting even richer with more rich kids.

Competing schools are more efficient

Economists have long advocated that competition improves the efficiency of an industry. Elementary education, however, is typically a state monopoly, and where private education is offered, it is typically much more expensive as not subsidized. While there are locations where voucher programs allow parents to use the subsidy elsewhere, it is hard to find examples where public systems compete with each other.

David Card, Martin Dooley and Abigail Payne look at an example that comes close to this: Ontario, Canada, has a parallel state school system for Catholics. The later can choose where to send their children, and thus the spatial variation in the proportion of Catholics in the population can provide interesting insights in the efficiency of local schools.

The general idea is that in areas with a larger share of Catholics, non-catholic schools has larger incentives to improve to attract these children, especially if parents are not particularly attached to religious education. Using detailed data at the school and child level, this study finds that competition does indeed improve performance as measured by student achievement. One more example highlighting that school choice is good.