Industrial Organization Field Exam. May 2013

Transcription

1 Industrial Organization Field Exam May 2013 This exam is a closed book, closed notes exam. You may use a calculator. There are four (4) questions on this exam. You are to answer three (3) questions of your choice.

2 Question 1 Consider a private road from point A to point B of length 1. Ownership of the road is divided among N individuals who each own 1/N th of the road. Let p i denote the toll that individual i charges travelers for driving on its section of the road. Operating costs are zero. Total demand for traveling on the road is given by D(P) = a bp, where N P = i=1 p i. a) Suppose that the firms set prices simultaneously. Derive the reaction function of individual i. b) Solve for the Nash Equilibrium prices (i.e., the equilibrium p i s). Is this solution unique? c) How does the equilibrium market price P and quantity D(P) change with N? Would the consumers be better off under a monopoly or under perfect competition? Give a brief intuition for your finding. Question 2 Consider a monopolist with one indivisible unit to sell. There are N potential buyers, whose values for the good are private information. It is common knowledge that buyers valuations are iid draws from the uniform distribution on a support normalized to [0,1]. a) If the monopolist can commit to a take-it-or-leave-it posted price, what price should the monopolist set? b) If the monopolist conducts a second-price sealed-bid auction, what are the buyers equilibrium strategies if one rules out the use of dominated strategies? c) If the monopolist conducts a first-price sealed-bid auction, what are the buyers equilibrium strategies if one rules out the use of dominated strategies? d) Compare expected profits as a function of N under the three schemes and comment on your results. Note: The distribution of the greatest of N iid draws from a distribution function F is given by G 1 (x) := F(x) N. The distribution function of the second largest of N iid draws from a distribution function F is given by G 2 (x) := F(x) N + N[(1 F(x))F(x) N-1 ]

3 Question 3 Unlike many other countries, doctors in Japan not only prescribe drugs but also purchase and dispense them to their patients. The Autumn 2007 RAND Journal of Economics contains an article by Toshiaki Iizuka entitled Experts Agency Problems: Evidence from the Prescription Drug Market in Japan. Toshiaki Iizuka s paper tests whether physician prescription decisions are influenced by the markup they receive. Specifically, do physicians choose drugs based not only on efficacy, safety, and cost, but to some extent on the markup they obtain? The markup received by the doctor is the difference between the retail and wholesale price of the drug. The Japanese government regulates retail prescription drug prices using a pricing formula called Yakka Kijyun. The government determines the retail price of the drug in comparison to similar drugs already on the market and whether the drug is of higher quality than existing ones. While the government sets the retail price, the wholesale price is determined freely by the pharmaceutical companies. Because physicians pocket the difference between the wholesale price (their purchasing price) and the retail price, pharmaceutical companies offering a low wholesale price could increase the amount of the drug prescribed by doctors. Toshiaki Iizuka uses annual information on 40 hypertension drugs for Along with product characteristic information, the annual data includes retail price, physician markup, various product attributes, and quantity sold for each drug. There are five major therapeutic classes of the drugs used to treat hypertension. They are angiotensin converting enzyme (ACE) inhibitors, calcium blockers, a- blockers,?-blockers, and diuretics. These drugs are differentiated in various ways. Most importantly, the mechanisms of actions to reduce hypertension are distinctively different across these five therapeutic classes, and drugs in each class share similar mechanisms of actions and have similar chemical structures. Most Japanese are insured under universal health coverage. Fees for medical services (including prescription drugs) are standardized by the government. Thus, all physicians get the same reimbursement for the same treatment, and doctors have to charge the same price for all patients. Patients pay different copayments depending on their eligibility. One important distinction exists in the amount of copayments that patients have to pay. Specifically, whereas elderly people (over age 70) pay fixed copayments per visit (about $5) regardless of the cost of the prescription, non-elderly people pay a proportion of the cost, which ranges between 10% and 30% depending on eligibility. The table below presents estimates from a nested logit regression where the dependent variable is market share. [The doctor is assumed to first decide on one of the five major therapeutic classes of the drugs and then to decide which drug in the chosen class to prescribe.] Column (1) includes estimates from a nested logit where physician markup and retail price are not instrumented for while Column (2) includes estimates where markup and retail price are instrumented with the following constructed variables: I. the number of drugs and the sum of product characteristics for other products sharing the same therapeutic class, and II. the number of drugs and the sum of product characteristics for other products sold by the firm selling the given product.

4 a. What conclusions would you draw regarding moral hazard from the coefficient estimates in the above table? b. As noted above, elderly people (over age 70) pay fixed copayments per visit (about $5) regardless of the cost of the prescription while non-elderly people pay a proportion of the cost, which ranges between 10% and 30%. How does this affect the interpretation of the coefficient estimates associated with markup and price in the above table? c. Are there selection issues that concern you with the above estimation? Explain. d. Intuitively, explain how the coefficients associated with mark-up and price may be bias in the first column of the above table when Toshiaki Iizuka does not instrument. e. What concerns do you have with using variables in (I) and (II) above as instruments to address the endogeneity of physician mark-up and price? f. Berry, Levinsohn and Pakes (BLP) proposed a random coefficient discrete choice estimation procedure that allows for less restrictive assumptions on elasticities relative to McFadden s nested logit estimation above. Explain the advantages of the BLP estimation procedure in regards to the elasticity assumptions. g. Sketch a simple model that would result in a single crossing condition consistent with the positive coefficient associated with physician market in the above table. Make sure you clearly identify notation and derive the single crossing property.

5 Question 4 There is extensive empirical evidence that social ties mitigate moral hazard in the group-lending context in developing countries. A 2011 paper, entitled Do Social Connections Reduce Moral Hazard? Evidence from the New York City Taxi Industry in the American Economic Journal: Applied Economics, looks at the role of social networks in aligning the incentives of economic agents in a different setting with incomplete contracts. This paper analyzes the outcomes of New York City taxi drivers who lease (as opposed to own) their taxis and compare the outcomes of those who lease from an owner from the same country of birth (termed in-network drivers) to the outcomes of those who lease from an owner from a different country of birth (termed out of network drivers). They use country of birth as the measure of social connectedness because this has been found to be an important social connection in other contexts. The taxi leasing market is a prime candidate for studying moral hazard because lessee drivers pay less or none of many of the variable costs they generate, including vehicle maintenance, repair, replacement, and insurance, and hence have incentives to choose inefficient levels of vehicle usage, care, and risk. The dataset used to test for moral hazard contains information about all drivers of New York City yellow taxis during two time periods: the spring of 2005 and fall of With these two time periods, the authors are able to obtain two observations on many drivers and have the ability to match these observations. The outcome of interest involves summonses which are given for a range of violations such as passenger service refusals, using the taxi for unlawful purpose, and missing required items from the taxi such as the display of the driver s taxi-driving license. Some of the driver violations generate costs for owners directly: owners receive fines for missing items, missing trip records, and vehicle condition violations stemming from the actions of drivers to whom they lease. Some of these driver violations generate costs for owners indirectly: using the taxi for an unlawful purpose may risk the taxi (for example, temporary impounding), hazardous moving violations, and possibly shift violations, in particular smoking in the taxi. The empirical difficulty in isolating the causal (effort) effect of in-network driving is that innetwork drivers may differ from out-of-network drivers in important unobserved ways. Because of this, the paper uses three research designs that rely on distinct sources of variation and different identifying assumptions. Columns 3 through 7 in the table below present the results of these three research designs where the outcome of interest is the number of summons for the driver. Note that Columns 3 and 4 include driver fixed effects. Assuming that the distance from a driver s residence to the nearest same-country owner s residence is unrelated to underlying driver ability, Columns 5 and 6 uses this distance measure as an exogenous instrument for driving in-network. (Note that only the second stage is presented in the table.) Finally, the authors aggregate the data to the country-ofbirth level to compare the outcomes of drivers from countries with high rates of in-network driving to drivers from countries with low rates of in-network driving. These results are presented in Column 7.

6 In all three research designs (Columns 3/4, Columns 5/6 and Column 7) those drivers who lease from an owner from the same country of birth (in network) have fewer summons than those drivers who least from an owner from a different country of birth (out of network). a. For each regression design, explain the variation that is identifying the coefficient associated with lease in-network. b. For each regression design, provide an alternative explanation other than moral hazard that would result in a negative coefficient estimate associated with the lease in-network variable.