Markets and the Welfare

‘Measuring the Welfare Effects of Residential Energy Efficiency Programs,’ Allcott, H. (with L.Braghieri, S. Eichmeyer, M. Gentzkow), 2019.

The rise of social media has provoked both optimism about potential societal benefits and concern about harms such as addiction, depression, and political polarization. We present a randomized evaluation of the welfare effects of Facebook, focusing on US users in the run-up to the 2018 midterm election. We measured the willingness-to-accept of 2,743 Facebook users to deactivate their Facebook accounts for four weeks, then randomly assigned a subset to actually do so in a way that we verified. Using a suite of outcomes from both surveys and direct measurement, we show that Facebook deactivation (i) reduced online activity, including other social media, while increasing offline activities such as watching TV alone and socializing with family and friends; (ii) reduced both factual news knowledge and political polarization;(iii) increased subjective well-being; and (iv) caused a large persistent reduction in Facebook use after the experiment. Deactivation reduced post-experiment valuations of Facebook, but valuations still imply that Facebook generates substantial consumer surplus.

Regressive Sin Taxes, with an Application to the Optimal Soda Tax,’ Allcott, H. (with B. Lockwood, D. Taubinsky), 2019.

A common objection to “sin taxes”—corrective taxes on goods that are thought to be over-consumed, such as cigarettes, alcohol, and sugary drinks—is that they often fall disproportionately on low-income consumers. This paper studies the interaction between corrective and redistributive motives in a general optimal taxation framework and delivers empirically implementable sufficient statistics formulas for the optimal commodity tax. The optimal sin tax is increasing in the price elasticity of demand, increasing in the degree to which lower-income consumers are more biased or more elastic to the tax, decreasing in the extent to which consumption is concentrated among the poor, and decreasing in income effects, because income effects imply hat commodity taxes create labor supply distortions. Contrary to common intuitions, stronger preferences for redistribution can increase the optimal sin tax, if lower-income consumers are more responsive to taxes or are more biased. As an application, we estimate the optimal nation-wide tax on sugar-sweetened beverages, using Nielsen Home scan data and a specially designed survey measuring nutrition knowledge and self-control. Holding federal income tax rates constant, our estimates imply an optimal federal sugar-sweetened beverage tax of 1 to 2.1 cents per ounce, although optimal city-level taxes could be as much as 60% lower due to cross-border shopping.

‘Should We Tax Soda? An Overview of Theory and Evidence,’ Allcott, H. (with B. Lockwood, D. Taubinsky), 2019.

Taxes on sugar-sweetened beverages are growing in popularity and have generated an active public debate.Are they a good idea? If so, how high should they be? Are such taxes regressive? People in the U.S.and some other countries consume remarkable quantities of sugar-sweetened beverages, and the evidence suggests that this generates significant health costs. Building on recent work by Allcott, Lockwood, and Taubinsky (Forthcoming) and others, we review the basic economic principles that determine the socially optimal SSB tax. The optimal tax depends on (1)externalities: un internalized health system costs from diseases caused by sugary drink consumption; (2) internalizes: costs consumers impose on themselves by consuming too many sugary drinks due to poor nutrition knowledge or lack of self-control; and (3)regressively: how much the financial burden and the internality benefits from the tax fall on the poor.We summarize the empirical evidence about the key parameters that determine how large the tax should be. Our calculations suggest that sugar-sweetened beverage taxes are welfare enhancing, and indeed that the optimal SSB tax rate may be higher than the one cent per ounce rate most commonly used in U.S.cities. We end with seven concrete suggestions for policymakers considering an SSB tax.

Food Deserts and the Causes of Nutritional Inequality,’ Allcott, H. (with R. Diamond, J. Dube, J.Handbury, I. Rahkovsky, M. Schnell), 2019.

We study the causes of “nutritional inequality”: why the wealthy eat more healthfully than the poor in the United States. Exploiting supermarket entry and household moves to healthier neighborhoods, we reject that neighborhood environment contribute meaningfully to nutritional inequality. We then estimate a structural model of grocery demand, using new instruments exploiting the combination of grocery retail chains’ differing presence across geographic markets with their differing comparative advantages across product groups. Counterfactual simulations show that exposing low-income households to the same products and prices available to high-income households reduces nutritional inequality by only about ten percent, while the remaining90 percent is driven by differences in demand. These findings counter the argument that policies to increase the supply of healthy groceries could play an important role in reducing nutritional inequality.

‘ Hedonistic Altruism and Welfare Economics,’ Ray, D., 2018.

When intergenerational altruism is hedonistic and not obligatory, the resulting equilibrium outcome is never socially optimal, even when all generations have standard, time-consistent preferences which incorporate future utility via value functions. The associated social welfare function is time-inconsistent, and exhibits future bias.

‘Measuring the Welfare Effects of Residential Energy Efficiency Programs,’ Allcott, H. (with M.Greenstone), 2017.

This paper sets out a framework to evaluate the welfare impacts of residential energy efficiency programs in the presence of imperfect information, behavioral biases, and externalities, then estimates key parameters using a 100,000-household eld experiment. Several results run counter to conventional wisdom: we and no evidence of informational or behavioral failures thought to reduce program participation, there are large unobserved benefits and costs that traditional evaluations miss, and realized energy savings are only 58 percent of predictions. In the context of the model, the two programs we study reduce social welfare by $0.18 per subsidy dollar spent, both because subsidies are not well-calibrated to estimated externality damages and because of self-selection induced by subsidies that attract households whose participation generates low social value. However, the model predicts that perfectly calibrated subsidies would increase welfare by $2.53 per subsidy dollar, revealing the potential of energy efficiency programs.

‘Relative Price Dispersion: Evidence and Theory,’ Menzio .G (with G. Kaplan, L. Rudanko, N. Trachter), H., 2016.

We use a large dataset on retail pricing to document that a sizeable portion of the cross-sectional variation in the price at which the same good trades in the same period and in the same market is due to the fact that stores that are, on average, equally expensive set persistently different prices for the same good. We refer to this phenomenon as relative price dispersion. We show that relative price dispersion might stem from sellers’ attempts to discriminate between high-valuation buyers who need to make all of their purchases in the same store and low-valuation buyers who are willing to purchase different items from different stores. We calibrate our theory and show that it is not only consistent with the extent and sources of dispersion in the price that different sellers charge for the same good, but also with the extent and sources of dispersion in the prices that different households pay for the same basket of goods.

‘Real-Time Pricing and Electricity Market Design,’ Allcott, H., 2013.

This paper considers two related distortions in electricity markets: the lack of real-time retail pricing and the suppression of peak wholesale prices due to Installed Capacity requirements. I lay out a framework for understanding these problems using a two-stage entry model in which producers with multiple technologies set capacity and then sell electricity into wholesale markets as demand varies over time. The model is calibrated to supply and demand conditions in the PJM electricity market. I estimate that moving from 10 percent of consumers on real-time pricing to 20 percent would increase welfare in PJM by $120 million per year. However, the welfare gains from clearer signals of scarcity prices under an Energy Only market design are more than twice as large. Furthermore, equilibrium peak prices in the Energy Only design drop to reasonable levels once a moderate share of retail consumers are on real-time pricing.

‘Advertising, Mass Consumption and Capitalism,’ Benhabib, J. and A. Bisin, 2002.

We identified a Postmodernist Critique of the organization of society which suggests that the interaction of monopoly power and advertising creates negative welfare effects for consumers. In particular, advertising takes the form of the “manipulation of preferences,’ leads consumers to “work and spend cycles” and subjects them to the “commodification of leisure.” We studied the interaction of monopoly power and advertising in a simple general equilibrium model, constructed to satisfy the basic postulates of this Critique (especially in terms of the effects of advertising on consumers’ preferences) and we identified specifications and parameter configurations of our model that give rise to equilibria which could support the Postmodernist Critique. Our analysis may provide a framework for the empirical analysis of the relevance of the Critique. In particular, it may be important to assess more precisely the relevance of the component of advertising that is stressed in the Critique, that of the “manipulation of preferences” relative to its informational component. The empirical relevance of the distortion caused by advertising relative to the many distortions and frictions present in the U.S. economy (from incompleteness of financial markets and borrowing constraints, to asymmetric information and distortionary taxation schemes) also remains to be established.

‘A Case for Incomplete Markets,’ Cogley, T. and T. Sargent (with L.E. Blume, D.A. Easley, and V. Tsyrennikov), 2015.

We propose a new welfare criterion that allows us to rank alternative financial market structures in the presence of belief heterogeneity. We analyze economies with complete and incomplete financial markets and/or restricted trading possibilities in the form of borrowing limits or transaction costs. We describe circumstances under which various restrictions on financial markets are desirable according to our welfare criterion.

‘The Long and the Short of It: Sovereign Debt Crises and Debt Maturity,’ Fernandez, R. (with A. Martin), 2015.

We present a simple model of sovereign debt crises in which a country chooses its optimal mix of short and long-term debt contracts subject to standard contracting frictions: the country cannot commit to repay its debts nor to a specific path of future debt issues, and contracts cannot be made state contingent. We show that in order to satisfy incentive compatibility the country must issue short-term debt, which exposes it to roll-over crises and inefficient repayments. We examine two policies — restructuring and re-profiling — and show that both improve ex ante welfare if structured correctly. We show that how debt payments in times of crises is distributed across creditors in immaterial. What matters instead is how the surplus generated by restructuring is divided between the country and its creditors.

‘Yogurt choose consumers? Identification of random utility models via two-sided matching,’ Galichon, A. (with O. Bonnet, K O’Hara and M. Shum), 2018.

In this paper we show that the problem of demand inversion in multinomial choice models is equivalent to the determination of stable outcomes in matching models. This result is very general and applies to random utility models that are not necessarily additive or smooth. Based on this equivalence, we argue that the algorithms for the determination of stable matchings can provide effective computational methods to inverse multinomial choice models, and we give a numerical benchmark of these algorithms. Our approach allows to estimate models that were previously difficult to estimate, such as the pure characteristics model, as well as non-additive
random utility models. The equivalence also allows to exploit the theory of stable matchings in order to describe important properties of the set of utilities solution to the demand inversion problem, and to study the cases of existence and uniqueness of identified utilities, as well as obtain consistency results.

‘Taxation in Matching Markets,’ Galichon, A. (with A. Dupuy, S. Jaffe, and S Kominers), 2017.

We analyze the effects of taxation in two-sided matching markets, i.e. markets in which all agents have heterogeneous preferences over potential partners. In matching markets, taxes can generate inefficiency on the allocative margin by changing who is matched to whom, even if the number of workers at each firm is unaffected. While the allocative inefficiency of taxation need not be monotonic in the level of the tax when transfers flow in both directions, we show that it is weakly increasing in the tax rate for markets in which workers refuse to match without a positive wage.

We introduce a renormalization that allows for an equivalence between markets with taxation and markets without taxation but with adjusted match values. We use our equivalence to show additional properties of matching markets with taxation and to adapt existing econometric methods to such markets. We then estimate the preferences in the college-coach US football matching market and show through simulations of tax reforms that the true deadweight loss can differ dramatically from that measured without accounting for the preference heterogeneity of the matching market.

In addition to highlighting the potential for allocative distortions from taxation, our model provides a continuous link between canonical models of matching with and without transfers.

‘A Model of Decentralized Matching without Transfers,’ Galichon, A. (with Y. Hsieh), 2018.

We propose a non-transferable utility (NTU) model of matching with unobserved heterogeneity in tastes that serves as a counterpart to Choo and Siow’s celebrated model in the transferable utility (TU) case. Our model captures an exchange economy with indivisible goods, fixed prices and no centralized assignment mechanism. To study such decentralized matching markets, we suggest a solution concept called “equilibrium under rationing-by-waiting”, which is new in a matching context, and in which a non-transferable numeraire (e.g., time) replaces a transferable numeraire (e.g., money) as the competitive market-clearing device. The matching function that we obtain is a Leontief function, whereas Choo and Siow obtained a Cobb-Douglas function. We then investigate the properties of equilibrium (existence, uniqueness, and welfare) and show that the equilibrium outcome can be obtained using a modified deferred-acceptance algorithm, with Gale-Shapley’s proposal/disposal phases replaced by linear programming problems. Finally, we study the connection of equilibrium under rationing-by-waiting to the classical NTU matching theory based on pairwise stability and aggregate/large NTU matching.

‘Single market nonparametric identification of multi-attribute hedonic equilibrium models,’ Galichon, A. (with V. Chernozhukov, M. Henry and B. Pass ), 2015.

This paper derives conditions under which preferences and technology are non-parametrically identified in hedonic equilibrium models, where products are differentiated along more than one dimension and agents are characterized by several dimensions of unobserved heterogeneity. With products differentiated along a quality index and agents characterized by scalar unobserved heterogeneity, single crossing conditions on preferences and technology provide identifying restrictions. We develop similar shape restrictions in the multi-attribute case and we provide identification results from the observation of a single market. We thereby extend identification results in Matzkin (2003) and Heckman, Matzkin, and Nesheim (2010) to accommodate multiple dimensions of unobserved heterogeneity.

‘Middlemen in Limit-Order Markets,’ Jovanovic, B. (with A.J. Menkveld), 2015.

A limit order market enables an early seller to trade with a late buyer by leaving a price quote. Information arrival in the interim period creates adverse selection risk for the seller and therefore hampers trade. Entry of high-frequency traders (HFTs) might restore trade as their machines can refresh quotes quickly on (hard) information. Empirically, HFT entry reduced adverse selection by 23% and increased trade by 17%. Model calibration shows that one percentage point more of the gains from trade were realized. Finally, we show that a well-designed double auction raises this to ten percentage points.

‘Trading on Sunspots,’ Jovanovic, B. (with V. Tsyrennikov), 2015.

In a model with multiple Pareto-ranked equilibria we endogenize the equilibrium selection probabilities by adding trade in assets that pay based on the realization of a sunspot. Asset trading imposes restrictions on the equilibrium set in a way that raises welfare. When the probability of a low-output outcome is high enough, the coordination game becomes more like a prisoner’s dilemma in which the high-output equilibrium disappears because of the asset positions that agents trade towards induce some agents not to invest. We derive an upper bound on the probabilities of the low-output equilibrium that we interpret as a disaster. We derive asset pricing implications including the disaster premium, and we study the effect on stock prices of news shocks to beliefs.

‘Foreign Ownership of U.S. Safe Assets: Good or Bad?’ Ludvigson, S.C. (with J. Favilukis and S. Van Nieuwerburgh), 2016.

The last 20 years have been marked by a sharp rise in international demand for U.S. reserve assets, or safe stores-of-value. What are the welfare consequences to U.S. households of these trends, or of a reversal? In a lifecycle model with aggregate and idiosyncratic risks, the young and oldest households may benefit substantially from such capital inflows, but middle-aged savers may suffer from greater exposure to systematic risk in equity and housing markets. Under the veil of ignorance, a newborn in the lowest wealth quantile is willing to forego 3% of lifetime consumption to avoid a large capital outflow.

‘The Welfare Effects of Intertemporal Price Discrimination: An Empirical Analysis of Airline Pricing in U.S. Monopoly Markets,’ Lazarev, J., 2013.

This paper studies how a firm’s ability to price discriminate over time affects production, product quality, and product allocation among consumers. The theoretical model has forward-looking heterogeneous consumers who face a monopoly firm. The firm can affect the quality and quantity of the goods sold each period. I show that in the model the welfare effects of intertemporal price discrimination are ambiguous. I use this model to study the time paths of prices for airline tickets offered on monopoly routes in the U.S. Using estimates of the model’s demand and cost parameters, I compare the welfare travelers receive under the current system to several alternative systems, including one in which free resale of airline tickets is allowed. I find that free resale of airline tickets would increase the average price of tickets bought by leisure travelers by 54% and decrease the number of tickets they buy by 10%. Their consumer surplus would decrease by only 16% due to a more efficient allocation of seats and the opportunity to sell a ticket on a secondary market.

‘Simulating the Dynamic Effects of Horizontal Mergers: U.S. Airlines,’ Lazarev, J. (with L. Benkard and A. Bodoh-Creed), 2010.

We propose a new method for studying the medium and long run dynamic effects of horizontal mergers. Our method builds on the two-step estimator of Bajari, Benkard, and Levin (2007). Policy functions are estimated on historical pre-merger data, and then future industry outcomes are simulated both with and without the proposed merger. In our airline entry model, an airline’s entry/exit decisions are made jointly across route segments, and depend on features of its own route network as well as the networks of the other airlines. We also allow for city-specific profitability shocks that affect all route segments out of a given city, as well as segment-specific shocks. Using data for 2003-2008, we apply our model to three recently proposed airline mergers. We find that a merger between two major hub carriers leads to increased entry by the other hub carriers, and can lead to substantial increased entry by low cost carriers, both effects offsetting some of the initial concentrating effects of the merger. Our model also suggests that a merger between two hub carriers can in certain cases lead to dismantling of a hub.

‘Getting More from Less: Understanding Airline Pricing,’ Lazarev, J., 2012.

Motivated by pricing practices in the airline industry, the paper studies the incentives of players to publicly and independently limit the sets of actions they can play later in a game. I find that to benefit from self-restraint, players have to exclude all actions that create temptations to deviate and keep some actions that can deter deviations of others. I develop a set of conditions under which these strategies form a subgame perfect equilibrium and show that in a Bertrand oligopoly, firms can mutually gain from self-restraint, while in a Cournot oligopoly they cannot.

‘Matching and Chatting: An Experimental Study of the Impact of Network Communication on School-Matching Mechanisms,’ Schotter, A. (with T. Ding), 2016.

While, in theory, the school matching problem is a static non-cooperative one shot game, in reality the “matching game” is played by parents who choose their strategies after consulting or chatting with other parents in their social networks. In this paper we compare the performance of the Boston and the Gale-Shapley mechanisms in the presence of chatting through social networks. Our results indicate that allowing subjects to chat has an important impact on the likelihood that subjects change their strategies and also on the welfare and stability of the outcomes determined by the mechanism.