The area in economics in which I conduct research is known as Industrial Organization. Industrial organization is a sub-field of microeconomics that studies the functioning of imperfectly competitive markets. In particular, industrial organization is concerned with business behavior and strategy in imperfectly competitive markets, as well as the implications that such behavior and strategy have for economic welfare. A specific behavior of firms in imperfectly competitive markets that has received considerable attention from industrial organization economists is that of mergers between firms.
A merger is a transaction in which the assets of two or more firms are combined in a new firm. One of the central issues in industrial organization is how mergers affect firm conduct and market performance. Retrospective studies of mergers tend to focus on the price effects of the relevant merger. To wit, do we observe the merging firms increase or decrease the price of their products subsequent to merging? Assuming product quality is unchanged by the merger, consumer welfare is inversely related to the price change of the merged firm's products. However, due to reasons subsequently discussed below, a merged firm may produce products of different quality relative to pre-merger product quality, and changes in product quality directly affect consumer welfare.
Departing from the extant literature in industrial organization that largely focuses on the price effects of mergers, a recent research paper that I coauthored with Yongmin Chen (University of Colorado, Boulder), investigates how two recent airline mergers affect the quality of air travel products offered by the airlines that merged. The paper is entitled: “Mergers and Product Quality: Evidence from the Airline Industry.”
Why might mergers cause the quality of products offered by a merged firm to change relative to pre-merger product quality? The research paper posits two key effects through which a merger may influence product quality: (1) Coordination effect; and (2) Incentive effect.
The coordination effect is the situation in which a merger by two firms allows them to share technical information and coordinate production activities, which can positively affect the quality of their products. For example, an airline merger may allow the two airlines to coordinate their flight schedules to better serve consumer needs. On the other hand, the incentive effect occurs when a merger reduces the competitive pressure on the firms to improve product quality, which can negatively affect the quality of their products. For example, competing airlines in an origin-destination market may have each provided nonstop and intermediate stop(s) products prior to merging, but find it profitable to eliminate the more travel-convenient nonstop product post-merger. Therefore, using a simple theoretical model, we argue that whether a merger raises or lowers product quality depends crucially on the relative strengthens of the coordination and incentive effects.
The two airline mergers we study are: (1) Delta Airlines merger with Northwest Airlines, which occurred in 2008; and (2) United Airlines merger with Continental Airlines, which occurred in 2010.
The research focuses on a specific measure of air travel product quality, which we refer to as Routing Quality. Routing quality relates to the travel convenience of the product itinerary, and is measured by the percentage ratio of nonstop flight distance to the product's itinerary flight distance used to get passengers from the origin to destination. Therefore, the routing quality variable takes on only positive values, where the maximum value is 100 in the case that the product itinerary uses a single nonstop flight to get passengers from the origin to destination. The presumption is that, holding all other factors constant, passengers prefer an itinerary that uses the most direct routing to get to their destination, so a higher value of the routing quality measure is associated with a more passenger-desirable travel itinerary.
The empirical analysis focuses on a sample of US domestic air travel markets and yields two key findings.
First, we find that the mergers increased routing quality of the merging firms’ products in markets where the merging firms did not compete with each other prior to the merger. In these markets the negative incentive effect of the merger on product quality is absent since the merging firms did not compete with each other prior to their merger. Thus the positive effect of the mergers on product quality in these markets is driven by the coordination effect, i.e., the merging airlines coordinate their route networks to offer products with better routing quality for consumers in these markets.
Second, we find that the mergers decreased routing quality of the merging firms’ products in those markets in which the airlines directly competed prior to their merger. Since both the coordination and incentive effects of a merger on product quality are present in those markets, the evidence suggests that the negative incentive effect of the mergers is stronger than the positive coordination effect. In other words, in those markets the mergers serve to sufficiently reduce the competitive pressure on the airlines to maintain or improve product quality, thus resulting in products of lower quality post-merger.
Since changes in product quality directly affect consumer welfare, the evidence provided in this research suggests that the standard practice in merger reviews that consider mainly the price effects may lead to substantial under- or over-estimate of a merger’s consumer benefit or harm. It would thus be desirable to explicitly incorporate product quality considerations into merger reviews. The insights from this paper may stimulate further research on merger-specific quality considerations and thereby inform public policy on the merits of proposed mergers.
Philip Gayle presented this paper at The 12th Annual International Industrial Organization Conference, April 11-13, 2014, held at the Northwestern University Law Searle Center on Law, Regulation and Economic Growth. The paper is also currently under review at a peer-reviewed economics journal.
The formation of preferential trade agreements (PTAs) is among the most notorious features of the international trade system. These PTAs allow member countries to exchange preferential access to each other's markets while fulfilling their obligations to the World Trade organization (WTO). More than three hundred PTAs have been created since WWII and others are under negotiation among various countries. The North America Free Trade Area (NAFTA) and the European Union (EU) are some of the many examples of PTAs discussed in popular media channels. Most PTAs take the form of free trade areas (FTAs) and customs unions (CUs). The former allows member countries to set tariffs against non-members independently while the latter requires that member countries coordinate their external tariffs by imposing common external tariffs.
In a recent paper, assistant professor Peri da Silva, in co-authorship with Giovanni Facchini (Nottingham University) and Gerald Willmann (Bielefeld University), propose a political-economy of trade framework with which to understand the greater popularity of FTAs relative to CUs. In their paper, they consider the formation of preferential agreements between economies under the presence of geographic specialization, i.e., each prospective member produces a different set of final goods. Most of the literature finds that coordination of external tariffs leads to the conclusion that the average voter is better off under CUs than under FTAs. Prof. da Silva and co-authors show that this need not be the case. They show that tariff coordination leads voters to strategically delegate power to very protectionist representatives. This finding leads to the conclusion that the average voter may be better off under FTAs than under CUs. They also discuss the political viability of the two kinds of PTAs and show that the conditions under which FTAs are politically more palatable than CUs. This paper is forthcoming in the Journal of International Economics.
An Essay on the Art and Science of Teaching
In a departure from his typical research on antitrust and regulatory economics, Dennis Weisman, Professor of Economics, recently published an article on teaching principles (“An Essay on the Art and Science of Teaching,” The American Economist, Spring 2012). Based on three decades of lectures to university students, corporate executives, regulators and legislators, this article integrates lessons from Charles Franklin Kettering—one of America’s most prolific inventors and commentators on education and industrial progress—to develop twelve principles for effective teaching.
Teaching Principle 1. Effective teaching strikes a delicate balance between the self confidence that students must develop to become independent thinkers and the humility they must maintain to recognize how much more they have to learn.
Teaching Principle 2. Effective teaching entails transmitting the subject matter on a number of different “frequencies” to accommodate the heterogeneous nature of how students learn.
Teaching Principle 3. The effectiveness of the lecture is limited by the students’ willingness to “buy” what the teacher is “selling.”
Teaching Principle 4. The effective teacher never confuses indoctrination with teaching because the objective is to develop thinkers not “parrots.”
Teaching Principle 5. The use of the Soft Socratic Method is superior to the traditional Socratic Method because teaching by facilitation is more effective than teaching by interrogation.
Teaching Principle 6. The effective teacher uses his research to enhance his teaching and his teaching to enhance his research while recognizing the importance of taking the long view.
Teaching Principle 7. The dissemination of knowledge is maximized when the teacher develops multiple communication pathways and encourages interdisciplinary thinking.
Teaching Principle 8. Effective teaching is less about providing students with the right answers and more about developing in them the ability to ask the right questions.
Teaching Principle 9. The effective teacher crafts his lectures to play to his strengths in communicating the material in the classroom, be it through humor, music, poetry, etc.
Teaching Principle 10. The well-planned lecture like the general’s battle plan should be sufficiently flexible in design to allow for real-time adjustments necessary to address unforeseen obstacles encountered in the course of the “struggle.”
Teaching Principle 11. We fail our students when we teach them the material without also instructing them on the most effective methods to communicate what they have learned.
Teaching Principle 12. The teachers’ effectiveness is not measured by the numbers on the teaching evaluations at the end of the term, but by what they have helped their students to achieve over the course of a lifetime.
Professor Weisman credits his former students, friends and colleagues for their feedback in developing these teaching principles. The article may be accessed here.
Recent research projects by Yang-Ming Chang, professor of economics, include an examination of differences between the U.S. antitrust case and the E.U. antitrust case against Microsoft. In 2000, the U.S. Department of Justice called for Microsoft’s breakup for reasons that included the following: it monopolized the market for the operating systems; the integration of its browser, Internet Explorer(IE), into the Windows operating system was anti-competitive; its free distribution of IE was predatory; it engaged in anti-competitive contracts with personal computer manufactures and internet service providers; it impeded product innovation; and its competitive actions harmed consumers. But the U.S. government’s antitrust litigation against Microsoft was eventually overturned. In the E.U. Microsoft case, the European Community argued that Microsoft had abused market dominance in its operating systems by tying the sales of Windows Media Player or IE to Windows. Unlike the U.S. case, the E.U. was successful in ruling against Microsoft and the company was required to offer a clean version of Windows (without any browser or application software). Yang-Ming and his coauthor, Hung-Yi Chen, a Ph.D. in economics from Kansas State and currently a full professor at Soochow University, develop an economic model to capture the idiosyncratic characteristics of the operating system monopoly (i.e., Windows dominance) and of the oligopolistic market for browsers (IE, Netscape’s Navigator, or Opera). They examine the case of tying behavior in which Microsoft integrates IE into Windows to generate a bundled system good for sales, as compared to the no-tying case when Microsoft is required by the government to break into smaller entities. Their findings indicate that Microsoft’s tying enhances price competition in the browser market and the integration of IE with Windows as a system good is socially desirable. This is directly related to the fact that Windows is an essential component and the fact that it is run on more than ninety percents of all personal computers. Based on their model, they show that a Microsoft breakup stifles competition, hurts consumers, and is socially undesirable. The results of their study further indicate that the E.U. international antitrust intervention against Microsoft as a foreign exporter benefits the E.U. software producers at the expense of their computer users. The paper also addresses issues on international antitrust and protection of domestic industries in the E.U. case. Yang-Ming presented this paper on March 17, 2012, at the 10th Annual International Industrial Organization Conference, which was held at George Mason University in Arlington, Virginia.
It is widely believed that higher oil prices lead to inflation. Based on the experience of the 1970's and 1980's, most introductory macroeconomics textbooks teach students that a higher price of oil increases the cost of producing goods, which is then passed on to consumers in the form of higher prices. Research by Lance Bachmeier, associate professor of economics, and Inkyung Cha, visiting assistant professor of economics, has shown that is not the case. They examined the behavior of more than 100 "core" consumption goods, such as clothing, toys, and household appliances, and found that most prices either do not change or even fall when the price of oil rises. They find that the main reason oil shocks are no longer inflationary is that firms have adopted energy-efficient production technology. Firms use about half the energy to produce the same goods today as in 1970. Their paper was published in the September 2011 issue of the Journal of Money, Credit and Banking.