Price Setting in an Innovative Market
2013-04 :: With Copeland :: February 2013
We examine how the confluence of competition and upstream innovation influences downstream firms' profit-maximizing strategies. In particular, we analyze how, in light of these forces, the downstream firm sets the price of the product over its life cycle. We focus on personal computers (PCs) and introduce two novel data sets that describe prices and sales in the industry. Our main result is that a vintage-capital model that combines a competitive market structure with a rapid rate of innovation is well able to explain the observed paths of prices, as well as sales and consumer income, over a typical PC's product cycle. The analysis implies that rapid price declines are not caused by upstream innovation alone, but rather by the combination of upstream innovation and a competitive environment.
Decomposing Medical-Care Expenditure Growth
2012-26 :: With Dunn and Liebman :: November 2012
Medical-care expenditures have been rising rapidly, accounting for almost one-fifth of GDP in 2009. In this study, we assess the sources of the rising medical-care expenditures in the commercial sector. We employ a novel framework for decomposing expenditure growth into four components at the disease level: service price growth, service utilization growth, treated disease prevalence growth, and demographic shift. The decomposition shows that growth in prices and treated prevalence are the primary drivers of medical-care expenditure growth over the 2003 to 2007 period. There was no growth in service utilization at the aggregate level over this period. Price and utilization growth were especially large for the treatment of malignant neoplasms. For many conditions, treated prevalence has shifted towards preventive treatment and away from treatment for late-stage illnesses.
Subprime Outcomes: Risky Mortgages, Homeownership Experiences, and Foreclosures
FRB Boston WP 07-15 :: With Gerardi and Willen :: May 2008
This paper provides the first rigorous assessment of the homeownership experiences of subprime borrowers. We consider homeowners who used subprime mortgages to buy their homes, and estimate how often these borrowers end up in foreclosure. In order to evaluate these issues, we analyze homeownership experiences in Massachusetts over the 1989-2007 period using a competing risks, proportional hazard framework. We present two main findings. First, homeownerships that begin with a subprime purchase mortgage end up in foreclosure almost 20 percent of the time, or more than 6 times as often as experiences that begin with prime purchase mortgages. Second, house price appreciation plays a dominant role in generating foreclosures. In fact, we attribute most of the dramatic rise in Massachusetts foreclosures during 2006 and 2007 to the decline in house prices that began in the summer of 2005.
Decomposing the Foreclosure Crisis: House Price Depreciation versus Bad Underwriting
FRB Atlanta WP 2009-25 :: With Gerardi and Willen :: September 2009
We estimate a model of foreclosure using a data set that includes every residential mortgage, purchase-and-sale, and foreclosure transaction in Massachusetts from 1989 to 2008. We address the identification issues related to the estimation of the effects of house prices on residential foreclosures. We then use the model to study the dramatic increase in foreclosures that occurred in Massachusetts between 2005 and 2008 and conclude that the foreclosure crisis was primarily driven by the severe decline in housing prices that began in the latter part of 2005, not by a relaxation of underwriting standards on which much of the prevailing literature has focused. We argue that relaxed underwriting standards did severely aggravate the crisis by creating a class of homeowners who were particularly vulnerable to the decline in prices. But, as we show in our counterfactual analysis, that emergence alone, in the absence of price collapse, would not have resulted in the substantial foreclosure boom that was experienced.
Geographic Variation in Commercial Medical-Care Expenditures: A Framework for Decomposing Price and Utilization
Manuscript :: With Dunn and Liebman :: January 2012
This study introduces a new framework for measuring and analyzing medical-care expenditures applied to the study of commercial medical-care markets. The framework focuses on expenditures at the disease level that are decomposed between price and utilization. These measures show that a particular MSA may have high overall prices, but may actually have low medical-care spending per episode due to low utilization. Prices within an MSA appear to be quite homogeneous, implying that regional factors explain a large degree of price variation. However, within an MSA there is a large degree of heterogeneity in utilization patterns between disease categories. This implies that most MSAs do not have systematically high or low utilization for all disease categories. We find evidence of a negative correlation between price and utilization across MSAs for many diseases, so it appears that the greater expenditures from higher prices are partly offset by lower utilization.
The Impact of Competition on Technology Adoption: An Apples-to-PCs Analysis
Manuscript :: With Copeland :: May 2011
We analyze how market structure affects a computer manufacturer's decision to embed a new technology into its product. We first provide a descriptive analysis of the computer manufacturing industry, measuring the rates of technology adoption by manufacturers and illustrating the joint dynamics of income, prices and sales over a typical computer's life cycle. We then develop and calibrate a dynamic vintage-capital model which rationalizes the co-movements of income, prices and sales with the observed rates of technology adoption. A main result from the model is that market structure is central to a computer manufacturer's adoption decision, whereby more competition leads to faster rates of adoption. When there is more competition among retail manufacturers, upstream innovations are more quickly embodied into retail products and passed along to consumers.
Physician Market Power and Medical-Care Expenditures
Manuscript :: With Dunn :: January 2011
We study the degree to which greater physician market power via consolidation leads to higher service prices in the commercially insured medical-care market. We also examine whether these potentially higher service prices translate into different levels of physician service utilization. We find that physicians in more concentrated markets charge higher service prices. However, due to the unique nature of patient cost sharing as well as the incentives of physicians, these higher prices lead to either no change or, in some cases, an expansion of services. This is in contrast to a typical market, where higher prices attributable to consolidation are thought to decrease quantity demanded.
Implications of Consumer Heterogeneity on Price Measures for Technology Goods
Manuscript :: With Aizcorbe :: August 2010
Using a new dataset on household purchases of personal computers (PCs), we document positive correlations between buyers' incomes and the prices they pay for seemingly identical PCs. These results suggest that firms may be successful at separating the market and charging different prices to consumers with different levels of willingness to pay. We consider the implications of this kind of market separation for price and quality measurement via a theoretical model based on Mussa and Rosen (1978). The model suggests that, in markets like these, standard methods that do not account for this heterogeneity can understate inflation in a cost-of-living context. Consistent with the model, our empirical work shows that controlling for income yields indexes that show slower price declines than seen in standard indexes. This understatement of the cost-of-living measure likely mitigates the unrelated upward biases found in recent studies by Bils (2009), Erickson and Pakes (2010), Broda and Weinstein (2010).
Medical-Care Price Indexes for Patients with Employer-Provided Insurance: Nationally-Representative Estimates from MarketScan Data
Forthcoming in Health Services Research :: With Dunn, Pack, and Liebman
Price Dispersion Over the Business Cycle: Evidence from the Airline Industry
The Journal of Industrial Economics 60(3), September 2012 :: With Cornia and Gerardi
This study provides empirical evidence documenting how price dispersion moves with the business cycle in the airline industry. Performing a fixed-effects panel analysis on 17 years of data covering two business cycles, we find that price dispersion is highly pro-cyclical. This effect is especially pronounced for legacy carriers relative to low-cost carriers. We show that our empirical result is consistent with firms implementing second-degree price-discrimination tactics.
Strategic Alliance as a Response to the Threat of Entry: Evidence from Airline Codesharing
International Journal of Industrial Organization, August 2012 :: With Goetz
Strategic alliances are arrangements in which firms combine efforts and resources to jointly pursue a business objective while remaining separate entities. An example of such a practice is airline codesharing, in which allied carriers engage in the cooperative marketing of certain flights. We empirically test for the presence of competitive motives behind such alliances by identifying an incumbent airline's use of codesharing in response to the threat of future entry by a competitor. Using within-flight segment, fixed-effects regressions on panel data from 1998-2010, we estimate the impact of exogenous threats of entry on an airline's decision whether to codeshare with a partner on a specific segment. Estimates show that when an incumbent carrier's segment is threatened by a low-cost competitor it is approximately 25% more likely than average to be codeshared with its partner. Further tests show that this effect depends strongly upon the level of market share that the airline has on the segment in question. We interpret this as evidence of a strategic alliance being used to preemptively act in anticipation of future competition.
Does Competition Reduce Price Dispersion? New Evidence from the Airline Industry
Journal of Political Economy 117(1), February 2009, 1-37, 02 :: With Gerardi
We analyze the effects of competition on price dispersion in the airline industry, using panel data from 1993:Q1 through 2006:Q3. Competition has a negative effect on price dispersion, in line with the text-book treatmetn of price discrimination. This effect is pronounced for routes wtih consumers characterized by relatively heterogeneous elasticities of demand. On routes wtih a homogeneous customer base, the effects of competition on price dispersion are smaller. Our results contrast with those of Borenstein and Rose, who found that price dispersion increases with competition. We reconcile the different results by showing that the cross-sectional estimator suffers from omitted-variable bias.
Estimating the New Keynesian Phillips Curve: A Vertical Production Chain Approach
Journal of Money Credit and Banking 40(4), 2008, 627-666
It has become customary to estimate the New Keynesian Phillips Curve (NKPC) with GMM using a large instrument set that includes lags of variables that are ad hoc to the model. Researchers have also conventionally used real unit labor cost (RULC) as the proxy for real marginal cost, even though it is difficult to support its significance. This paper introduces a new proxy for the real marginal cost term as well as a new instrument set, both of which are based on the micro foundations of the vertical chain of production. I find that the new proxy, based on input prices as opposed to wages, provides a more robust and significant fit to the model. Instruments that are based on the vertical chain of production appear to be both more valid and relevant towards the model. This paper was revised in July 2006.