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The Frontiers of Knowledge awards recognize the fathers of empirical industrial organization

Timothy Bresnahan, Ariel Pakes and Robert Porter study the impact of businesses in the market. To measure this ability that firms have to control prices in a given industry, the three Frontiers of Knowledge laureates in Economics have developed methods that have had a significant and lasting impact on empirical research in the industrial organization field, as well as in other applied fields like health or environmental economics.

According to the jury, Timothy Bresnahan’s work has laid the foundations for the new empirical industrial organization. “We have been very concerned,” Bresnahan explained after hearing of the award, “that declines in the degree of competition in many markets in the rich countries have led to an increase in market power,” with the result that “technical progress, which should serve to lower prices for consumers, has instead been captured by sellers.”

Robert Porter, in the words of the citation, “has made several important theoretical and empirical contributions to the study of collusion, especially in the context of auctions.”  Porter, a professor at Harvard University has studied ways to detect and prevent collusive practices; agreements between two or more parties to elude competition by conspiring, for instance, to raise consumer prices, to lower the prices paid to suppliers or to block the entry of new competitors.

Ariel Pakes’ (Northwestern University, USA) major contribution has been the development of econometric models and methods for studying demand and productive efficiency.  His models to estimate demand and substitution patterns in differentiated product markets have enjoyed a wide take-up in both academia and in regulatory and professional analyses of antitrust questions.

Further, his productivity estimation methods have become a standard tool in the empirical study of industrial output.

According to José Garcia Montalvo, Professor of Economics at Pompeu Fabra University, in Pakes’ analysis “everything is linked to everything else.  When a firm takes some action – for instance, cutting its prices – other firms respond according to factors like demand and costs, and this, in turn, provokes a reaction from competitors.  What we have, in essence, is a chain of action and reaction that will gradually return the market to conditions of equilibrium.”

Applications in Healthcare

The jury points out that the models developed by Bresnahan, Pakes and Porter are used by antitrust authorities in many parts of the world, including the United States and the European Union, since the tools they designed provide insights into market functioning and can determine where agent transactions might distort competition.

“I think my favorite example,“ Bresnahan explains, “is my empirical studies on the beer industry. Jonathan Baker and I wrote about the beer industry a long time ago, and our work has come to underlie methodologically almost all the merger reviews carried out by antitrust agencies, because we figured out how to forecast the anti-competitive effects of a merger.”

Bresnahan, Pakes and Porter’s methods, the citation continues, “have had applications in other areas of economics, including macroeconomics, international trade and health and environmental economics.”

In the healthcare area, Pakes recalls a case where “we studied the allocation of patients to hospitals.  There are two ways of doing this in the U.S. One is fee-per-service, where the doctor and hospital get a fee for each service provided.  And then there is “capitation”, where the medical group gets a set amount for each patient, and if they don’t spend it all can save some of what’s left.  So the big question was: Would this cause hospitals to skimp on quality of patient care?  What we found is that “capitated” doctors do send patients to cheaper hospitals but without sacrificing quality. They send them to less convenient hospitals of equal quality, maybe further out of the city where they live.”

All three laureates are currently working to translate these models to today’s markets:  “It is essential,” Timothy Bresnahan stresses, “that we understand new industries (finance and high tech particularly) well enough to deploy effective competition policies.  That is the biggest challenge facing the field.”

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