Worst-Case Bounds on R&D and Pricing Distortions: Theory and Disturbing Conclusions if Consumer Values Follow the World Income Distribution Comments by: Severin Borenstein E.T. Grether Professor of Business and Public Policy, Haas School of Business University of California, Berkeley University of Chicago -- December 3, 2015 Worst-Case Bounds on R&D and Pricing Distortions: Theory and Disturbing Conclusions if Consumer Values Follow the World Income Distribution by Kremer and Snyder

Very intuitive characterization of static versus dynamic DWL University of Chicago -- December 3, 2015 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

Careful assessment extraction ratios under various demand functions Extraction ratios at the static profit-max price But d  /dP is zero at profit max while dDWL/dP is first order. So, other factors could have big effect on dDWL/dP.  What sort of other factors? Rational firm factors like dynamic pricing in a multi- period 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

And how much will firms really know about demand shape? Demand will be estimated with noise  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

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  Is this case easier because consumers are non- strategic price- and contract-takers?  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?  Regulatory threat  Fear of hold-up reputation  Customer search threat Distributional considerations generally University of Chicago -- December 3, 2015

Economy-wide Second-Best Considerations Public Finance / Environmental Economics take this seriously, but IO generally passes 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