Experimentation in Two-Sided Markets

Abstract:

We study optimal experimentation by a monopolistic platform in a two-sided market framework. The platform provider faces uncertainty about the strength of the externality each side is exerting on the other. It maximizes the expected present value of its profit stream in a continuous-time infinite-horizon framework by setting participation fees or quantities on both sides. We show that a price-setting platform provider sets a fee lower than the myopically optimal level on at least one side of the market, and on both sides if the two externalities are of approximately equal strenght. If the externality that one side exerts is sufficiently weaker than the externality it experiences, the optimal fee on this side exceeds the myopically optimal level. We obtain analogous results for expected prives when the platform provider chooses quantities. While the optimal policy does not admin closed-form representations in general, we identify special cases in which the undiscounted limit of the model can be solved in closed form.

Keywords: Two-Sided Market, Network Effects, Monopoly Experimentation, Bayesian Learning, Optimal Control

JEL-Classification: D42, D83, L12

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365.pdf

Ownership and Control in a Competitive Industry

Abstract:

We study a differentiated product market in which an investor initially owns a controlling stake in one of two competing firms and may acquire a non-controlling or a controlling stake in a competitor, either directly using her own assets, or indirectly via the controlled firm. While industry profits are maximized within a symmetric two product monopoly, the investor attains this only in exceptional cases. Instead, she sometimes acquires a noncontrolling stake. Or she invests asymmetrically rather than pursuing a full takeover if she acquires a controlling one. Generally, she invests indirectly if she only wants to affect the product market outcome, and directly if acquiring shares is profitable per se.

Keywords: Differentiated products, separation of ownership and control, private benefits of control.
JEL Classification: L13, L41.
February 2011

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350.pdf

Competition and Trust: Evidence from German Car Manufacturers

Abstract:

We explore the determinants and effects of trust relationships between upstream suppliers and downstream producers. Using unique survey data on individual supplier-buyer relationships in the German automotive industry, we show, by means of different measures of supplier-buyertrust, tha thigher levels of trust mitigate relationship-specific underinvestment in a classical hold-up situation. Moreover, contrary to the extant literature, we show that higher levels of supplier’s trust are reflected in the buyer’s choice of a more competitive procurement strategy among potential suppliers.

Keywords: Trust, Hold-up problem, Competition, Specific investment, Suppliers, Car manufacturers, German automotive industry

JEL Classification: D86,D22,L22,L62

February 2011

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349.pdf

Who Should Pay for Certification?

Abstract:

Who does, and who should initiate costly certification by a third party under asymmetric quality information, the buyer or the seller? Our answer — the seller — follows from a non–trivial analysis revealing a clear intuition. Buyer–induced certification acts as an inspection device, whence seller–induced  certification acts as a signalling device. Seller–induced certification maximizes the certifier’s profit and social welfare. This suggests the general principle that certification is, and should be induced by the better informed party. The results are reflected in a case study from the automotive industry, but apply also to other markets – in particular the financial market.

Keywords: asymmetric information, certification, information acquisition, inspection, lemons, middlemen, signaling

JEL Classification: D40, D82, L14, L15

June 2010

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323.pdf

Consumer Loss Aversion and the Intensity of Competition

Abstract:

Consider a differentiated product market in which all consumers are fully informed about match value and price at the time they make their purchasing decision. Initially, consumers become informed about the prices of all products in the market but do not know the match values. Some consumers have reference-dependent utilities—i.e., they form a reference-point distribution with respect to match value and price that will make them realize gains or losses if their eventually chosen product performs better or, respectively, worse than their reference point in both dimensions. Loss aversion in the match-value dimension leads to a less competitive outcome, while loss aversion in the price dimension leads to a more competitive equilibrium than a market in which consumers are not subject to reference dependence. Depending on the weights consumers attach to the price and the match-value dimension, a market with loss-averse consumers may be more or less competitive than a market with consumers that do not have reference-dependent utilities. We also show that consumer loss aversion tends to lead to higher prices if the market accommodates a larger number of firms.

Keywords: Loss Aversion, Reference-Dependent Utility, Behavioral Industrial Organization, Imperfect Competition, Product Differentiation

JEL Classification: D83,L13,L41,M37

May 2010

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319.pdf

Centralizing Information in Networks

Abstract:

Abstract: In the dynamic game we analyze, players are the members of a fixed network. Everyone is initially endowed with an information item that he is the only player to hold. Players are offered a finite number of periods to centralize the initially dispersed items in the hands of any one member of the network. In every period, each agent strategically chooses whether or not to transmit the items he holds to his neighbors in the network. The sooner all the items are gathered by any individual, the better it is for the group of players as a whole. Besides, the agent who first centralizes all the items is offered an additional reward that he keeps for himself. In this framework where information transmission is strategic and physically restricted, we provide a necessary and suffcient condition for a group to pool information items in every equilibrium. This condition is independent of the network structure. The architecture of links however affects the time needed before items are centralized in equilibrium.

Keywords: communication network, communication dilemma, dynamic network game, strategic

JEL Classification: D83, C72, L22

April 2010

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313.pdf

Pricing and Information Disclosure in Markets with Loss-Averse Consumers

Abstract:

Abstract: We develop a theory of imperfect competition with loss-averse consumers. All consumers are fully informed about match value and price at the time they make their purchasing decision. However, a share of consumers are initially uncertain about their tastes and form a reference point consisting of an expected match value and an expected price distribution, while other consumers are perfectly informed all the time. We derive pricing implications in duopoly with asymmetric firms. In particular, we show that a market may exhibit more price variation the larger the share of uninformed, loss-averse consumers. We also derive implications for firm strategy and public policy concerning firms’ incentives to inform consumers about their match value prior to forming their reference point.

Keywords: Loss Aversion, Reference-Dependent Utility, Information Disclosure,
Price Variation, Advertising, Behavioral Industrial Organization, Imperfect Competition, Product Differentiation

JEL Classification: D83, L13, L41, M37

April 2010

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312.pdf

Returns to Inventors

Abstract:

A key input to inventive activity is human capital. Hence it is important to understand the monetary incentives of inventors. We estimate the effect of patented inventions on individual earnings by linking data on U.S. patents and their inventors to Finnish employer-employee data. Returns are heterogeneous: Inventors get a temporary reward of 3% of annual earnings for a patent grant and for highly-cited patents a longer-lasting premium of 30% in earnings three years later. Similar medium-term premia accrue to inventors who initially hold the patent rights, although they forego earnings at the time of the grant.

Keywords: citations, effort, incentives, inventors, intellectual property, patents, performance pay, return, wages

JEL Classification: O31, J31

March 2010

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309.pdf

Indirect Taxation in Vertical Oligopoly

Abstract:

This paper analyzes the effects of specific and ad valorem taxation in an industry with downstream and upstream oligopoly. We find that in the short run, i.e. when the number of firms in both markets is exogenous, the results concerning tax incidence tend to be qualitatively similar to models where the upstream market is perfectly competitive. However, both over- and undershifting are more pronounced, potentially to a very large extent. Instead, in the long run under endogenous entry and exit overshifting of both taxes is more likely to occur and is more pronounced under upstream oligopoly. As a result of this, a tax increase is more likely to be welfare reducing. We also demonstrate that downstream and upstream taxation are equivalent in the short run while this is not true for the ad valorem tax in the long run. We show that it is normally more efficient to tax downstream.

Keywords: Specific Tax, Ad Valorem Tax, Value-Added Tax, Tax Incidence, Tax Efficiency, Indirect Taxation, Imperfect Competition, Vertical Oligopoly

JEL Classification: D43, H21, H22, L13

Febuary 2009

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255.pdf

The Actual Structure of eBay’s Feedback Mechanism and Early Evidence on the Effects of Recent Changes

Abstract:

eBay’s feedback mechanism is considered crucial to establishing and maintaining trust on the world’s largest trading platform. The effects of a user’s reputation on the probability of sale and on prices are at the center of a large number of studies. More recent theoretical work considers aspects of the mechanism itself. Yet, there is confusion amongst users about its exact institutional details, which also changed substantially in the last few months. An understanding of these details, and how the mechanism is perceived by users, is crucial for any assessment of the system. We provide a thorough description of the institutional setup of eBay’s feedback mechanism, including recent changes to it. Most importantly, buyers now have the possibility to leave additional, anonymous ratings on sellers on four different criteria. We discuss the implications of these changes and provide first descriptive evidence on their impact on rating behavior.

Keywords: eBay, reputation mechanism, strategic feedback behavior, informational content, reciprocity, fear of retaliation
JEL Classification: D44, L15, L86
November 2007

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220.pdf

Internet Peering as a Network of Relations

Abstract:

We apply results from recent theoretical work on networks of relations to analyze optimal peering strategies for asymmetric ISPs. It is shown that - from a network of relations perspective – ISPs’ asymmetry in bilateral peering agreements need not be a problem, since when these form a closed network, asymmetries are pooled and information transmission is faster. Both these effects reduce the incentives for opportunism in general, and interconnection quality degradation in particular. We also explain why bilateral monetary transfers between asymmetric ISPs (Bilateral Paid Peering), though potentially good for bilateral peering, may have rather negative effects on the sustainability of the overall peering network.

November 2006

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191.pdf

Umbrella Branding and the Provision of Quality

Abstract:

Consider a two-product firm that decides on the quality of each product. Product quality is unknown to consumers. If the firm sells both products under the same brand name, consumers adjust their beliefs about quality subject to the performance of both products. We show that if the probability that low quality will be detected is in an intermediate range, the firm produces high quality under umbrella branding whereas it would sell low quality in the absence of umbrella branding. Hence, umbrella branding mitigates the moral hazard problem. We also find that umbrella branding survives in asymmetric markets and that even unprofitable products may be used to stabilize the umbrella brand. However, umbrella branding does not necessarily imply high quality; the firm may choose low-quality products with positive probability.

Keywords: Umbrella branding, reputation transfer, signaling, experience goods.
JEL Classification: L14, L15, M37, D82
June 2006

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132.pdf

Observable Reputation Trading

Abstract:

Is the reputation of a firm tradable when the change in ownership is observable? We consider a competitive market in which a share of owners must retire in each period. New owners bid for the firms that are for sale. Customers learn the owner’s type, which reflects the quality of the good or service provided, through experience. After observing an ownership change they may want to switch firm. However, in equilibrium, good new owners buy from good old owners and retain high-value customers. Hence reputation is a tradable intangible asset, although ownership change is observable.

Keywords: Reputation, ownership change, intangible assets, theory of the firm.
JEL Classification: D40, D82, L14, L15
June 2006

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131.pdf

“Ineffective” competition: a puzzle?

Abstract:

Conventionally, we think of an increase in competition as weakly decreasing prices, increasing the number of consumers served, thus increasing consumer surplus, decreasing firms profits, etc. Here, we demonstrate that, under some tame circumstances, an increase in competition may lead to a price increase in a horizontally differentiated market. We show this relationship for the petrol market in German cities.

May 2006

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117.pdf

Leniency Policies and Illegal Transactions

Abstract:

Forthcoming in the Journal of Public Economics
We study the consequences of leniency – reduced legal sanctions for wrongdoers who spontaneously self-report to law enforcers – on sequential, bilateral, illegal transactions, such as corruption, manager-auditor collusion, or drug deals. It is known that leniency helps deterring illegal relationships sustained by repeated interaction. Here we find that - when not properly designed - leniency may simultaneously provide an effective governance mechanism for occasional sequential illegal transactions that would not be feasible in its absence.

Keywords: amnesty, corruption, collusion, financial fraud, governance, hold up, hostages, illegal trade, immunity, law enforcement, leniency, organized crime, self-reporting, whistleblowers
JEL Classification: K42, K21
September 2005

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74.pdf

Last Minute Feedback

Abstract:

Feedback mechanisms that allow partners to rate each other after a transaction are considered crucial for the success of anonymous internet trading platforms. We document an asymmetry in the feedback behavior on eBay, propose an explanation based on the micro structure of the feedback mechanism and the time when feedbacks are given, and support this explanation by findings from a large data set. Our analysis implies that the informational content of feedback records is likely to be low. The reason for this is that agents appear to leave feedbacks strategically. Negative feedbacks are given late, in the "last minute," or not given at all, most likely because of the fear of retaliative negative feedback. Conversely, positive feedbacks are given early in order to encourage reciprocation. Towards refining our insights into the observed pattern, we look separately at buyers and sellers, and relate the magnitude of the effects to the trading partners' experience.

Keywords: eBay, reputation mechanism, strategic feedback behavior, informational content, reciprocity, fear of retaliation
JEL Classification: D44, L15, L86
March 2006

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62.pdf

An Economist's Guide to Digital Music

Abstract:

In this guide, we discuss the impact of digitalization on the music industry. We rely on market and survey data at the international level as well as expert statements from the industry. The guide investigates recent developments in legal and technological protection of digital music and describes new business models as well as consumers' attitude towards music downloads. We conclude the guide by a discussion of the evolution of the music industry.

Keywords: Music, Internet, File-sharing, Peer-to-peer, Piracy, Digital Rights Management, Copyright, E-commerce
December 2004

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32.pdf

File-Sharing, Sampling, and Music Distribution

Abstract:

The use of file-sharing technologies, so-called Peer-to-Peer (P2P) networks, to copy music files has become common since the arrival of Napster. P2P networks may actually improve the matching between products and buyers - we call this the matching effect. For a label the downside of P2P networks is that consumers receive a copy which, although it is an imperfect substitute to the original, may reduce their willingness-to-pay for the original - we call this the competition effect. We show that the matching effect may dominate so that a label’s profits are higher with P2P networks than without. Furthermore, we show that the existence of P2P networks may alter the standard business model: sampling may replace costly marketing and promotion. This may allow labels to increase profits in spite of lower revenues.

Keywords: file-sharing, P2P, sampling, information transmission, piracy, music
JEL Classification: L11, L82
December 2004

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31.pdf

Networks of Relations

Abstract:

We model networks of relational (or implicit) contracts, exploring how sanctioning power and equilibrium conditions change under different network configurations and information transmission technologies. In our model, relations are the links, and the value of the network lies in its ability to enforce cooperative agreements that could not be sustained if agents had no access to other network members’ sanctioning power and information. We identify conditions for network stability and in-network information transmission as well as conditions under which stable subnetworks inhibit more valuable larger networks.

Keywords: Networks, Relational Contracts, Indirect Multimarket Contact, Social Capital.
JEL Classification: L13, L29, D23, D43, O17
November 2004

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28.pdf

Trade, growth and geography: A synthetic

Abstract:

Economic integration affects economic development through two main channels: growth and localization of the economic activities. The theories of endogenous growth and economic geography enable us to understand these mechanisms. We study in this paper their similarities and specificities before suggesting their useful combination within a single model. Indeed, both theories are based on the same Spence-Dixit-Stiglitz monopolistic competition framework. However, they suggest two different approaches to deal with the impact of economic integration. We consider that a third path, by proposing a synthetic approach, better answers the issues raised in terms of economic convergence and divergence by these two sets of models.

Keywords: regional economic integration, endogenous growth, economic geography
JEL Classification: F12, F15, F43, O18, O30, O41, R11, R12, R13
March 2004

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22.pdf

Regional integration and economic development: An empirical approach

Abstract:

This paper contributes to the empirical literature by providing a quantitative measurement of the influence of regional trade integration on productivity. For this purpose we address the link between trade and productivity thanks to knowledge spillovers in a multi-country model. The interdependence that connects countries in an international web promotes exchanges of goods, services, people, capital and hence ideas, knowledge, innovation, and technology. Economic integration encourages thus both new ideas and their diffusion. We observe that a country’s productivity depends on its own R&D efforts as well as the R&D efforts of its trading partners. These R&D spillovers can then spread across countries and sectors. Thanks to the transfer of technology allowed by bilateral trade and investment, regional trade integration has a positive impact on long-term growth.

Keywords: regional economic integration, endogenous growth, economic geography
JEL Classification: F12, F15, F43, O18, O30, O41, R11, R12, R13
March 2004

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21.pdf

Regional integration and economic development: A theoretical approach

Abstract:

We use a model of combined endogenous growth and economic geography to study the impact of regional economic integration on the member and non-member countries of a regional union. Regional integration affects growth through interregional technology diffusion symbolized by knowledge spillovers generated at home and spreading to the partner countries. Spillovers flow from the leader to the follower. Following integration, the lagging country has access to a bigger stock of knowledge that fosters an increase in its rate of growth and extends the diversity of its products. Trade in goods - or in FDI - and flows of ideas are two faces of the same coin. We show that the progressive decrease in transaction costs through the phasing out of barriers to trade together with product imitation can foster growth and convergence in the member countries. However, in order to avoid eventual trade and investment diversions, the non-member should envisage to join the integrated zone.

Keywords: regional economic integration, endogenous growth, economic geography
JEL Classification: F12, F15, F43, O18, O30, O41, R11, R12, R13
March 2004

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20.pdf

Platform Ownership

Abstract:

Lecture on the first SFB/TR 15 meeting, Gummersbach, July, 18 - 20, 2004

We develop a general theoretical framework of trade on a platform on which buyers and sellers interact. The platform may be owned by a single large, or many small independent or vertically integrated intermediaries. We provide a positive and normative analysis of the impact of platform ownership structure on platform size. The strength of network effects is important in the ranking of ownership structures by induced platform size and welfare. While vertical integration may be welfare-enhancing if network effects are weak, monopoly platform ownership is socially preferred if they are strong. These are also the ownership structures likely to emerge.

Keywords: Two-Sided Markets, Network Effects, Intermediation, Product Diversity
JEL Classification: L10, D40
July 2004

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16.pdf