Contents. Research target and questions

Transcription

1 Deregulation, Prices and Search Costs in the Italian OtC Retail Market Leopoldo Trieste Sant Anna School of Advanced Studies Volterra, June 9th 2008

2 Research target and questions Contents Notes on the literature Deregulation, price and search costs Models of search and costs Standard and our approaches Conclusion of the present approach What do data say? Methodology and data sample Price correlations within and between chemist s and non prescrition chemists shops. Preliminary conclusions What next? How can we estimate search costs? How can we verify weather customers adopt a non sequential Vs. sequential search? 2

3 Research target and questions To analyse the effects of the Italian OtC market deregulation in terms of demand and supply side behaviour does a particular demand side behaviour exist able to reduce the potential positive effects of competition? prices, price volatility, search costs how can we estimate search costs? does deregulation affect search cost? are search costs and volatility (positively) correlated in the short run (after a liberalization policy)? How can we estimate this correlation? 3

4 Notes on the literature (1) Deregulation, price and search costs Neoclassical game theory approach (no explicit search costs) p oligopoly short run competition long run Pareto-efficient equilibrium M σ p 2 t deregulation t M: supply side size i.e., # of sellers 4

5 Notes on the literature (2) Deregulation, price and search costs Diamond paradox (1971): with homogeneous consumers the equilibrium price distribution in a sequential search economy degenerates at the monopoly price. Salop and Stiglitz (1977) developed a model of information cost asymmetry (no degeneration at the monopolistic price) on the demand side and one good on the supply side. Hypotheses: sellers are perfect informed on prices; firms propose their prices: the customer information set consists of a vector of prices but people are not able to assign a particular seller to each price. To be well informed consumers must support a fixed cost c. In Salop e Stiglitz there is an information source (a newspaper) and different way (different costs in term of personal capability, times and resources) to achieve the information needed. Population is divided into: i) perfect informed agents generate positive externalities inducing competitive behaviour on the supply side and reducing the market price for the uniformed consumers too; ii) uninformed consumers generate negative externalities since the informed agents must looking for new information at a non zero cost to obtain lower prices. 5

6 Notes on the literature (3) Deregulation, price and search costs Conclusion: In case of information gathering there is not an efficient price equilibrium and although there are only identical goods we should observe a price dispersion. Salop and Stiglitz do not investigate a) how consumers are able to achieve information on prices b) why should we pay a fixed cost to achieve information if price volatility was zero? c) how does price volatility affect search cost behaviour? d) their model is static. Anderson and Renault (1999) show how market prices rise with search costs and decrease with the number of firms. 6

7 Notes on the literature (4) Deregulation, price and search costs Search-cost (price rigidity) approach p oligopoly short run competition M E (C(I)) σ p deregulation positive correlation between search cost and price t volatility t 2 M: supply side size i.e., # of sellers. 7

8 Notes on the literature (5) Models of search and costs Morgan and Manning (1985 Econometrica) present a model optimal search. Search consists of drawing observation from a population X R. At time t = 1,, T-1 > 1 searcher decides weather or not to continue his/her search i.e., sequential search. The search problem is to determine the search rule which maximizes the searcher's expected utility. What is a search rule? Let Yt the set (at time t) of the searcher s knowledge (a vector of prices) achieved by the search activity from 0 to t A search rule is a sequence of pairs (Z,S)t Z: Yt I+ : the sample-size function: at time t searchers decides the size nt of the sample they want to investigate; S: Yt {0,1} : the stopping function: 0 if search is to continued at time t. 8

9 Notes on the literature (6) Models of search and costs the search procedure among time (Z,S)t I+ 1 o The set rules set t Def. A search rule is regular if and only if searcher does not stop his/her search if it is expected to improve his/her utility. Morgan and Manning show that there is a particular regular search rule which has highest expected value in the set of all the search rules sharing the same sequence of sample-size functions. 9

10 Notes on the literature (7) Models of search and costs Morgan and manning introduce a weak hypothesis that ensures that the searcher is able to form expectations about the value of continued search i.e., the integrability of the expected utility functional E[ ] <. (*) This weak hypothesis is sufficient for the existence of optimal search rules. At each time t searcher calculates the size of the sample he should draw from X in order to maximize the expected present value of continued search. Having decided this expected value he continues his search by drawing this sample if the expectation is no larger than the best terminal utility. *Is there a similar condition for the set L2 i.e., the 2 times integrable functions? It is an important question because it could useful to say that an optimal search rule exists even in the set of all chaotic and random search sequences (Z,S) t 10

11 Notes on the literature (8) Models of search and costs A) Non seqential search time t min p1, pn X B) Sequential search time t time t+1 min p1, pnt X min p1, pnt+1 X 11

12 Notes on the literature (9) Search costs Standard approach Prices are not correlated with search cost Volatility does not affect search costs: price volatility is the effect of search costs and customer etherogenity. (a static approach) Our approach Market deregulation induces customer to believe in a competitive asset pricing. Near a paradox: believing (expectation) in a competitive asset pricing reduces competitive behaviour. Price volatility and search costs are (positively) correlated in the short run (after a market deregulation): (a dynamic approach) volatility affects search costs We have not found a robust literature on the effects of prices variation and search costs expectation on the market deregulation itself 12

13 Notes on the literature (10) Deregulation, price and search costs Search costs (t) Search costs variation (t, t+1) (Salop Stiglitz) (our approach) Price volatility (t) 2 σ t = f c& t ( I) = ( c t ( I)) 2 g( σ t ) c& t ( I) = g o f ( c t ( I)) c ( t) = g He ( f ( t )) Where H is a constant H. Search costs could show an exponential trend but there are s brakes seemingly reducing search costs e. g., advertising. These brakes do not reduce search costs but they stop the search activity. 13

14 Conclusions of the present approach A. Customer expectation: deregulation increases competitive behaviour and reduce prices; B. Expectation of a competitive behaviour reduces the incentive to search because one believes that his/her seller s price reflects competitive asset pricing. i.e., prices are correlated by competitive behavior and prices depend each others. It induces a non competitive behaviour on the supply side; C. In the short run sellers adopt a price cutting strategy only for a small sample of products (loss leaders*): i.e., portfolio strategy. Prices within (between) are (are not) correlated, respectively. D. Price volatility and search costs are positively correlated in the short run after a market deregulation. * Through loss leaders we translate the Italian prodotti civetta although loss leaders products are forbidden in the Italian OtC market. 14

15 What do data say? (1) A) Customers expectation: deregulation increases competitive behaviour and reduce prices; AcNielsen sample of customers before deregulation (March 2006) Exp. effect May dereg. positively affect price reduction? May dereg. increase price competition between different shops? Yes (%) No (%) No opinion (%) 81,0 3,9 15,1 74,9 7,8 17, 3 This expectation on competition may reduce. short run competition 15

16 What do data say? (2) B. Expectation of a competitive behaviour reduces the incentive to search because one believes that his/her seller s price reflects a competitive behaviour; C. In the short run sellers adopt a price cutting strategy only for a small sample of products (loss leaders*): i.e., portfolio strategy. Prices within (between) are (are not) correlated, respectively. Price corr.s (only 95% significant), of a 10 OtC drugs basket prices in 17 Italian Regions chemists shop Chemists shop F1 F2 F3 F4 F5 F6 F7 F8 F9 F10 F1 1 F2 1 F3 0,836 1 F4 0,7831 0,952 1 F5-0,5274 0,8218 0,8741 0, F6 0,6818 0,6477 0,6229 0, F7 0,7437 0,6089 0,5926 0,5561 0, F8 0,6002 0,5923 0,7068 0, F9 0,5666 0,4791 0, F10 0,8666 0,7576 0,7277 0,6596 0,6683 0,6891 0,

17 What do data say? (3) C. In the short run sellers adopt a price cutting strategy only for a small sample of products (loss leaders*): i.e., portfolio strategy. Prices within (between) are (are not) correlated, respectively. Price corr.s (only 95% significant), of a 10 drugs basket in 17 Italian Regions; no prescription drugs shop No prescription drugs shop P1 P2 P3 P4 P5 P6 P7 P8 P9 P10 P1 1 P2 0, P3 0,9321 0, P4 0, P5 0,9805 0,9162 0, P6 0,7765 0,7048 0,6736 0, P7-0,5637-0, P8 0,9292 0,7983 0,9544 0,5133 0,9417 0, P9 0,8515 0,8204 0,7886 0,9475 0,7029 0, P10 0,9187 0,9083 0,8822 0,9456 0,7433 0,8708 0,

18 What do data say? (4) Between Pf1F Pf2F Pf3F Pf4F Pf5F Pf6F Pf7F Pf8F Pf9F Pf10F Price correlation Pf1P 0,1119-0,6799 Pf2P 0,3456 Price correlation for the same products -0,1898 Pf3P 0,1756-0,5155 Pf4P 0,0238-0,9303 Pf5P 0,116-0,116 Pf6P -0,0133-0,9609 Pf7P 0,432-0,3331 Pf8P 0,3887-0,1368 Pf9P 0,3325 Pf10P 0,166 Results: no significant correlations -0,2259-0,

19 What do data say? (5) Loyalty and people distribution by age. ACNielsen sample. Customer behaviour Age distribution >60 average he/she is a regular 50,8 51,4 66,7 55,4 visitor of the same chemist's he/she is not a regular 49,2 48,6 33,3 44,6 visitor of the same chemist's

20 What do data say? (6) Preliminary conclusion: why the short run effects of market deregulation are so weak? customers expectation on the effects of deregulation are predicted by the theory; the asset pricing does not follow a competitive criterium: prices between chemist s and no prescrition drugs * shops are not significant and weak correlated; portfolio strategies: prices within shops are strongly and significant correlated; loyalty (that is a form of search cost saving) and people distribution by age reduce the incentives to search. * We translate the Italian parafarmacia. 20

21 What next? (1) D. Price volatility and search costs are positively correlated in the short run after a market deregulation. Methodology changes in price volatility Price p.d.f A Price p.d.f. B n.p.e. Hong and Shum n.p.e. Hong and Shum Search cost p.d.f. A deregulation Search cost p.d.f. B changes in search costs p.d.f. 21

22 What next? (2) How can we estimate search costs How can we estimate search costs by price distribution? Two different search procedure. Non sequential search: the non parametric estimation for search costs by price distr. is relative simple. (1) Sequential search: while the non parametric estimation for search costs by price distrib. is very difficult. a parametric est. is easier (2). 22

23 What next? (3) Methodology We adopt the Hong and Shum s (2006 RAND Journal) approach (1) N. S. S. i s 1 s *( c) arg min c( s 1) + sp(1 F( p)) f ( p) dp = E i+ s> 1 p* p * * * p p i 1 Ei = p* + (1 F( p)) dp p* + (1 F( p)) p* p* i+ 1 f ( s, c) Since consumers are assumed to draw i.i.d. samples from the eq. price distribution, the marginal expected saving from searching i+1 versus i stores is s *( c) arg max i i dp A consumer with search costs c will search as long as the marginal expected saving exceeds her marginal search costs c: i > c 23

24 What next? (4) Methodology Hong and Shum (2006) N. S. S.,... 1 n i.e., the sequence of marginal expected saving can be interpreted as the search costs of the indifferent consumers. i is the search cost faced by the consumer who is indifferent between search i or i+1 q 4 q3 q2 q1 How can we estimate q? 24

25 What next? (5) 25 Methodology ) ( ) ( ~ ) ( ) ( ~ ) ( 1 ~ = = = c c c c c F F q F F q F q The search cost qantiles are estimated by the price distr. i.e., the retails equilibrium price conditions incorporate a way to draw a search costs p.d.f. Search costs p.d.f. by price p.d.f. Full scheme search cost est. variance by empirical likelihood.

26 What next? (6) (2) S. C. the non parametric estimation for search costs by price distrib. is very difficult. a parametric est. is easier. but one should know the a priori search costs p.d.f. family. Some authors use a Gamma function. We will try to find an easier way to est. a search costs distribution How can we verify if customers adopt non sequential Vs. sequential search? Although they are so important to explain price rigidity, there is a lack of the econometrics of search cost. It depends to the fact that there is not a direct measure of search costs, by definition; 26

27 What next? (7) Four papers: a) OtC, market deregulation and search costs, submitted to Economia e Politica Industriale b) The Italian OtC retail market history c) Future scenario in the Italian OtC Market. Work in progress d) The econometrics of search costs 27

28 Thank for your attention 28