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The effect of satellite entry on product quality for cable television

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  • Chenghuan Sean Chu
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    Abstract

    In vertically differentiated markets, the effects of firm entry are contingent upon whether incumbent firms can respond to entry by adjusting product quality in addition to simply lowering prices. Using market-level data, I estimate a structural model of supply and demand for subscription television that takes into account the endogeneity of quality choice. Using counterfactual analysis, I decompose the effect of satellite entry on existing cable into two components: the conventional price response and the effect of endogenous quality adjustments (measured by changes in programming content). Consistent with the empirical observation that cable prices rose during the 1990s and early 2000s "in spite of" increasing competition, I find that raising both price and quality for the most comprehensive subscription package--i.e., competing "head-to-head"--is the rational response to entry by cable systems in markets with relatively homogeneous consumer types. Elsewhere, incumbents respond less aggressively and relegate themselves to being the low-end provider. When an entrant credibly commits to serving consumers with the highest preferences for quality, competition over both price and quality lowers the welfare gains due to entry, relative to pure price competition. In particular, head-to-head competition results in "crowding" of quality choices toward the high end of the market and inefficiently low product differentiation. In such cases, consumers with weak quality preferences may actually become worse off following entry. The evidence also suggests that the observed degradation of the lowest-quality cable tier in many markets during this time period--while commonly seen as an attempt to evade price regulation--may actually have been welfare-enhancing.

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    Bibliographic Info

    Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2008-12.

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    Date of creation: 2008
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    Handle: RePEc:fip:fedgfe:2008-12

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    Keywords: Supply and demand ; Cable television industry;

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    References

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    1. Mortimer, Julie Holland, 2007. "Price Discrimination, Copyright Law, and Technological Innovation: Evidence From The Introduction of DVDs," Scholarly Articles 3425914, Harvard University Department of Economics.
    2. Austan Goolsbee & Amil Petrin, 2004. "The Consumer Gains from Direct Broadcast Satellites and the Competition with Cable TV," Econometrica, Econometric Society, vol. 72(2), pages 351-381, 03.
    3. repec:reg:rpubli:169 is not listed on IDEAS
    4. Crawford, Gregory S & Shum, Matthew, 2007. "Monopoly Quality Degradation and Regulation in Cable Television," Journal of Law and Economics, University of Chicago Press, vol. 50(1), pages 181-219, February.
    5. Mussa, Michael & Rosen, Sherwin, 1978. "Monopoly and product quality," Journal of Economic Theory, Elsevier, vol. 18(2), pages 301-317, August.
    6. Eric Maskin & John Riley, 1984. "Monopoly with Incomplete Information," RAND Journal of Economics, The RAND Corporation, vol. 15(2), pages 171-196, Summer.
    7. Andrew Cohen & Michael J. Mazzeo, 2004. "Competition, product differentiation and quality provision: an empirical equilibrium analysis of bank branching decisions," Finance and Economics Discussion Series 2004-46, Board of Governors of the Federal Reserve System (U.S.).
    8. David P. Myatt & Justin P. Johnson, 2004. "On the Simple Economics of Advertising, Marketing, and Product Design," Economics Series Working Papers 185, University of Oxford, Department of Economics.
    9. Corts, Kenneth S, 1995. "Regulation of a Multi-product Monopolist: Effects on Pricing and Bundling," Journal of Industrial Economics, Wiley Blackwell, vol. 43(4), pages 377-97, December.
    10. Gregory Crawford, 2008. "The discriminatory incentives to bundle in the cable television industry," Quantitative Marketing and Economics, Springer, vol. 6(1), pages 41-78, March.
    11. Jean-Charles Rochet & Lars A. Stole, 2002. "Nonlinear Pricing with Random Participation," Review of Economic Studies, Oxford University Press, vol. 69(1), pages 277-311.
    12. Stennek, Johan, 2007. "Exclusive Quality - Why Exclusive Distribution may Benefit the TV-viewers," Working Paper Series 691, Research Institute of Industrial Economics.
    13. Shaked, Avner & Sutton, John, 1982. "Relaxing Price Competition through Product Differentiation," Review of Economic Studies, Wiley Blackwell, vol. 49(1), pages 3-13, January.
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