Public Policy in Private Markets

1. Public Policy in Private Markets Information Policies

2. Announcements • 5/1: • Last day of classes • HW 7 due, will post soon • You will get exam 2 back, together with a “tentative” grade • Tue, 5/8 • Comprehensive final exam: • 4:00 – 6:00 pm, Thompson Hall 106

3. Overview of this Course Competition Policies (completed) Information Policies: information that is presented to consumer Product Quality policies: health, safety, quality Non-Price Consumer Protection

4. Example: Calorie posting • In 2008, NY became the first city to enforce restaurants to post calories on all food items (with font as large as price)

5. Calorie Posting • Does this policy help the consumer? • Yes, consumers make a better informed decision • Yes, consumers reduce unnecessary calorie consumption • No, it does not affect consumers’ consumption habits

6. Calorie Posting • Does this policy affect firm behavior? • Yes, firms reduce calorie content in their products • Yes, firms start offering new products • No, it does not alter firm behavior

7. Calorie Posting: Research Findings • Recent article by Bollinger, Leslie and Sorensen (2011): • Look at the effect of NYC’s calorie posting policy on Starbucks • Calories consumed decrease by 6% on average (but 26% for heavy users) • Calories per drink DO NOT decrease, decrease is entirely coming from less food purchases • Starbucks: profits remain unchanged and food offerings have been modified (smaller servings)

8. Why Do Consumers Need Protection? • Inadequate Information Leads to: • Errors of Commission • Buy more than you would if you had complete information (e.g. Starbucks? Acai berry) • Pre-purchase assessment is too favorable • Errors of Omission • Buy less than you would if you had complete information (e.g. nutritional yeast) • Pre-purchase evaluation is too unfavorable

9. Why Do Consumers Need Protection? • Claims: • increased energy levels, improved sexual performance, improved digestion, detoxification, high fiber content, high antioxidant content, improved skin appearance, improved heart health, improved sleep, and reduction of cholesterol levels

10. Why Do Consumers Need Protection? • Properties: • Important source of protein and vitamins (B-complex vitamins) and is a complete protein. Naturally low in fat and sodium.

11. Why Do Consumers Need Protection? • Result: • Purchasing decisions do not maximize utility • Competition is somewhat harmed: • Some products are rewarded “too much” while others are rewarded “too little”

12. Information problems • Why may these problems be serious? • Types of goods/qualities: • Search: consumer can judge qualities by inspection • E.g. tomato: color, size, etc. • Experience: quality can be judged post-purchase • E.g.: cell phone service by company X • Credence: can’t judge quality even after purchase • E.g.: pesticide residues on certain products

13. Information problems • Information problems more severe for goods with significant experience and credence qualities • Consumer has difficulty in judging quality • Gov’t regulation

14. Approaches to Consumer Protection • None; laissez-faire: markets provide products and information • Consumers: trial and error, word of mouth • Works best: • Attributes easily judged/researched: taste, color • No health hazard: experimentation is harmless • Inexpensive and frequently purchased • Works poorly: • Not easy to judge attributes • Hazardous products • Product is expensive and rarely purchased • Food? Computers?

15. Approaches to Consumer Protection 2. Rely on public actions, product liability • No formal regulation: people can sue company for damages • Works best: • Clear cause and effect link between product and damage • Harm is permanent (evidence is stronger) • Speed of correcting problem is not crucial • Works poorly: • Cause and effect is not clear (e.g. damage is 20 years later) • Speed of correcting problem is important

16. Example: Liability of Drug Companies • March, 2009 • Diana Levine (guitar player) sues Wyeth: improper administration of injection causes amputation of her arm • Vermont jury rules in favor of Levine, awards $7 mill in damages • Supreme Court on a 6-3 vote allows consumers to sue pharmaceutical companies for side effects even if label approved by FDA

17. Approaches to Consumer Protection 3. Use of Labels and Warnings • Government lowers cost of acquiring info • Works best: • Many consumers will use and benefit from info • Risk/other info can be communicated effectively • Banning a product might be desirable but it is not feasible (e.g. cigarettes) • Certain groups of consumers that are affected can be easily identified (e.g. pregnant women)

18. Approaches to Consumer Protection 3. Use of Labels and Warnings • Works poorly: • Important characteristics of product are hard to communicate • Risk is too high: society thinks decision should not be left to consumer.

19. Approaches to Consumer Protection 3. Use of Labels and Warnings • Works poorly: • Important characteristics of product are hard to communicate • Risk is too high: society thinks decision should not be left to consumer.

21. Approaches to Consumer Protection 4. Minimum Quality Standards (banning certain production processes) • Aimed at eliminating hazardous/detrimental products • Works best: • Risk is difficult to communicate • Risk is too high • Problem needs quick response • Works poorly: • Standards make products too costly • Society loses too much when product not available

22. Approaches to Consumer Protection 5. Gov’t research + info provision: • Gov’t provides information on what are better choices than others: • nutritional guidelines • crash testing ratings

23. Gov’t research + info provision:

24. Overview of this Course Competition Policies (completed) Information Policies: information that is presented to consumer Product Quality policies: health, safety, quality Consumer Protection

25. 2. Information Policies • Product Standardization and Information Disclosure • Regulation of Advertising and Selling Practices

26. 2. Information Policies • Product Standardization and Information Disclosure • Regulation of Advertising and Selling Practices

27. Product Standardization & Info Disclosure • Increase amount of info to consumers • Consumers better able to make good decisions • What is a good decision? • Not whether a consumer buys a healthy cookie or not, but whether he/she buys the cookie she intended

28. Product Standardization & Info Disclosure • Standardization for price comparisons: • Fair packaging + labeling Act of 1966: • Policy statement: provide packaging and labeling that facilitates value comparisons • Regulates info presented to consumers • FDA published set or regulations covering labeling and packaging • Where should the label be?

29. Label • Principal Display Panel (PDP): • Largest label usually displayed in retail packages • Rectangular: 1 whole side (cereal box) • Cylinder, 40% of side (stewed tomatoes) • Information Panel: • Label immediately contiguous to the PDP

30. Label

31. Standardization and Info Disclosure • Standardization for price comparisons: • Example: quantity labeling (under Fair packaging + labeling Act): • Net quantity stated in uniform and prominent location on package’s PDP • Net quantity clearly expressed in appropriate unit of measure (e.g. milk in fluid oz, napkins in counts) • Some countries mandate uniform package sizes

32. Standardization and Info Disclosure • Standardization for price comparisons: • Price Standardization: unit pricing (state laws) • Question, which of the following is cheaper on a per ozbasis: • Large size: 25 oz for 53 cents OR • Regular size: 1.5 lbs for 49 cents?

33. Standardization and Info Disclosure • Standardization for price comparisons: • Price Standardization: unit pricing (state laws) • Example: • Large size: 25 oz for 53 cents OR • Regular size: 1.5 lbs for 49 cents? • Large: 2.12 cents per oz • Regular: 2.04 cents per oz • Consumers don’t typically bring calculators to the store

34. Standardization and Info Disclosure • Quality disclosure (type of info disclosure): • How good is product? Turns experience and credence into search qualities • Four ways to do this: • Ingredient/content labeling • Clothing: fibers used • Performance • Estimated MPG on new cars • Energy guides on new appliances • Grade rating, standards • Organic labeling • Open dating • Perishables

35. Grade Rating: Example • Organic Foods Production Act, 1990: what “organic” means • Meat, poultry, eggs + dairy: animals not given antibiotics or hormones, organic feed, outdoor access. • Food: no pesticides, no synthetic fertilizers, no genetic engineering. • “100% organic”: only organic ingredients • “Organic”: >95% organic ingredients • “Made with organic ingredients”: >70%

36. Organic Standards • Prior to 1990 act: • Producers were often not honest about product • Consumers could not visually judge product • Rules varied from state to state. • Now: • USDA label (only for 100% organic) • Credence attribute is now search attribute • Consumers can purchase what they originally wanted