Distortions: Theory and Disturbing
the World Income Distribution
Comments by:
E.T. Grether Professor of Business and Public Policy,
University of California, Berkeley

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First in a monopoly setting
 Then oligopoly setting
 When a monopolist sets profit-maximizing price, (a) what share of potential market surplus does it capture and (b) how much
DWL does it create.
 Perfect price discrimination is ideal
 back to that in a moment
University of Chicago -- December 3, 2015

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Careful assessment extraction ratios under various demand functions
Extraction ratios at the static profit-max price
But d p
/dP is zero at profit max while dDWL/dP is first order. So, other factors could have big effect on dDWL/dP.
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What sort of other factors?
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Rational firm factors like dynamic pricing in a multiperiod market: lock-in, customer learning, response of competitors (in same or different “market”)
Less mainstream economic factors like empire building, loss aversion, over-confidence, managerial incentives
 Size of second-order loss from different P?
University of Chicago -- December 3, 2015

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And how much will firms really know about demand shape?
Demand will be estimated with noise
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What are the upside and downside risks of following estimated demand exactly to optimize price?
 In both simple price theoretic model and in organizational model of firm decision making
How should firm’s pricing model optimally incorporate new evidence of demand shape?
 Knowing that demand shape and level is moving target
 Evidence Zipf-similarity predicts markups?
University of Chicago -- December 3, 2015

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Entry Cost
Called “R&D”, but really any irreversible investment independent of output scale
 Requires enough surplus extraction to justify market entry
 Similar concern on buyer side with multiple purchases and long relationship that requires up-front investment (eg, learning) in product
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Is this case easier because consumers are nonstrategic price- and contract-takers?
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But these sellers may be competing against one another where buyers are not
University of Chicago -- December 3, 2015

Equity norms
 Recent drug price increases bring regulatory threat and reputation costs
 Non-economic angry response to scarcity pricing in the absence of market power
 Why do firms justify price increases?
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Regulatory threat
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Fear of hold-up reputation
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Customer search threat
 Distributional considerations generally
University of Chicago -- December 3, 2015

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Economy-wide Second-Best
Considerations
Public Finance / Environmental Economics take this seriously, but IO generally passes
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Example: Big positive society spillover to
(market-level) efficient pharmaceutical pricing and entry, less so in beer market
Won’t be able to track down every distortion, but to take welfare analysis seriously, some discussion of other distortions seems in order
University of Chicago -- December 3, 2015

Thank You!
University of Chicago -- December 3, 2015