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Culture, Society & Family Economics & Statistics

Why firms prefer not to disclose product quality — and how regulators might respond

Post author By Margaret Allen
Post date February 12, 2015

“This is a really exciting area of research where game theory based models can provide direct insights into behavior of market participants.” — Roy

Rather than explicitly revealing information about the quality of their products and services, many firms prefer to signal quality through the prices they charge, typically working on the assumption that a high price indicates high quality.

New research by Maarten Janssen, University of Vienna, and Southern Methodist University economist Santanu Roy provides a new explanation for why firms choose not to disclose quality directly – and explains how prices that are set to signal quality can distort actual buying decisions.

Their study, “Competition, Disclosure and Signalling,” which is published in the February 2015 issue of the Economic Journal, shows that when firms compete on price, not disclosing product quality voluntarily can soften competition and boost profits.

“We often use prices to form ideas about product quality. Firms understand this,” said Roy, a professor in SMU’s Department of Economics in Dedman College of Humanities & Sciences. “As a result, their strategic decisions about pricing and direct disclosure of product characteristics become intricately linked. Our research explains why firms may prefer not to disclose quality attributes of their products and instead induce buyers to try to infer quality from prices: it allows firms to sustain high prices despite strong competition.”

Finding may be a case for imposing mandatory disclosure regulation
The finding has an important policy implication for regulators: even if consumers infer all relevant product information from prices (or other actions by firms), there may be a case for imposing mandatory disclosure regulation. Such regulation can reduce market power and the price and consumption distortions resulting from firms’ use of prices to signal product quality.

“If you regulate and force firms to directly disclose quality attributes, prices may fall and lead to better market outcomes,” Roy said. “This is a really exciting area of research where game theory based models can provide direct insights into behavior of market participants. Our current research studies some related issues such as the case for ‘truth in advertising’ regulation and penalizing false advertising of product attributes.”

The researchers begin by noting that in a large number of markets, ranging from educational and health services to consumer goods and financial assets, sellers have important information about the quality of their products. Quality attributes include satisfaction from consuming the product, durability, safety and potential health hazards as well as ethical and environmental attributes.

Information about these quality attributes is not always publicly available to potential buyers or competitors. In many of these markets, firms have the option of voluntarily disclosing product information in a credible and verifiable manner – for example, through independent certification, rating agencies or regulated advertising.

Without hard, credible information about products, buyers associate higher prices with better quality
But in practice, firms do not disclose product quality very often, even when there are relatively cost-effective mechanisms for credible disclosure and even when the product quality itself is not bad.

For example, empirical studies find that hospitals often do not disclose risk-adjusted mortality; schools often do not report standardized test scores; restaurants almost never disclose hygiene inspection reports; and so on.

In fact, the reluctance of firms to disclose voluntarily may discourage the emergence of rating agencies and certification intermediaries in many industries. This study provides a new explanation for why firms do not wish to disclose quality.

The researchers’ explanation is based on the commonplace observation that even when there is no hard and credible information about products on the market, buyers often associate higher prices with better quality and cheap products with low quality.

Such beliefs held by buyers are rational in markets where firms anticipate this and choose their actions (such as prices) to convey the hidden information. Economists call this “signaling”: it is an alternative way of communicating private information by firms.

The researchers argue that firms may not disclose product attributes voluntarily because they find it more profitable to signal their information indirectly.

Excessively high price makes it credible to buyers that product could not be low quality
This is somewhat paradoxical at first glance. Economists have long maintained that signalling is costly for firms. For example, to signal high quality through high prices, a firm may have to charge a much higher price than in a situation where product quality was observed or disclosed, leading to loss of sales and profit. The excessively high price is needed to make it credible to buyers that this could not be a low quality product as the producer of such a product would have lower costs and therefore prefer to sell high volume at low price.

Why then would a firm prefer to signal rather than disclose? The answer lies in the strategic behavior of firms and market competition. The researchers show that when firms compete on price, not disclosing product quality voluntarily, competing under a “veil of incomplete information” can soften competition, leading to higher profits and a more collusive outcome.

Firms’ incentives to lower prices to steal business from their rivals are disciplined by the fact that buyers may associate lower prices with lower quality. The resulting market outcome can be one with higher profits for the nondisclosing firm. The strategic incentive for nondisclosure may be strong even when a firm has a strong competitive advantage in the market.

Absence of voluntary disclosure does not mean that consumers make uninformed decisions
In contrast with previous research on this issue, the new explanation of nondisclosure is not based on disclosure being too costly or imperfect. The researchers show that no firm may disclose product quality (including the ones with the best product quality), even if the mechanism for voluntary disclosure is almost costless and frictionless.

The researchers’ analysis indicates that the absence of voluntary disclosure does not mean that consumers make uninformed decisions; nondisclosure arises precisely when buyers infer quality from the market behavior of firms.

But markets may well be inefficient as the prices that are set to signal quality distort actual buying decisions. This leads to the important policy implication that there may be a case for imposing mandatory disclosure regulation on firms. — Royal Economic Society and Southern Methodist University

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Tags Dedman College, Santanu Roy, SMU Department of Economics

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The Economist: Goldilocks nationalism

Post author By Margaret Allen
Post date September 26, 2014

The size and homogeneity of a country’s population has a big bearing on its economic policies

The Economist’s “Free Exchange” column covered the research of SMU economist Klaus Desmet as part of a larger examination of the ideal size of nations from an economic perspective and within the context of Scotland’s recent vote on the question of independence.

The article, “Goldilocks nationalism,” published Sept. 27.

Desmet is an expert in international trade, regional and urban economics, macroeconomics and political economy. He is the Ruth and Kenneth Altshuler Centennial Interdisciplinary Professor in Economics.

Desmet’s research published in the Journal of Development Economics, “The political economy of linguistic cleavages,” and looked at the genealogical relationships between the world’s 6,912 languages.

The data revealed which linguistic cleavages are most relevant for a range of political economy outcomes.

Desmet and his co-authors on the study found “that deep cleavages, originating thousands of years ago, lead to better predictors of civil conflict and redistribution. The opposite pattern emerges when it comes to the impact of linguistic diversity on growth and public goods provision, where finer distinctions between languages matter.”

Read the full story.

EXCERPT:

The Economist
WHEN Scotland turned down independence, it was bucking a trend. Since 1946 the number of sovereign states has soared, from 76 to 197. The steady shrinking of the world’s political units raises the question of what the ideal size would be from an economic perspective. Separatists from Catalonia to the southern Philippines should be aware that a country’s population, economists believe, has a big impact on all sorts of policies, from the level of government spending to its openness to trade.

Separatists eyeing the exit have many motivations, but economics typically plays a big role in the choice to stay or go. In their book “The Size of Nations”, Alberto Alesina and Enrico Spolaore lay out the costs and benefits of going it alone.* Scale has its advantages: bigger countries are easier to defend from foreign aggressors, for instance. When barriers to trade are high, a bigger domestic market allows for more internal specialisation. A 19th-century British prime minister is reported to have complained to a French ambassador, “If you were not such persistent protectionists, you would not find us so keen to annex territories!” America’s size allowed it to develop new and highly productive forms of industry in the late 1800s, which Europe’s smaller countries could not match until tariffs fell in the 20th century.

Yet the bigger a country grows the more multitudes it contains. Larger populations are not always more diverse than smaller ones—Japan is both much larger and more homogenous than Belgium—but in larger countries there are generally more politically distinct subgroups. As the voting public becomes more heterogenous, the scope for intractable disputes over government policies grows.

Messrs Alesina and Spolaore reckon falling barriers to trade have reduced the cost of being a small state and boosted interest in separatism. Ironically, the European Union has made breaking up especially attractive. Catalan nationalists, for instance, assume that if Catalonia parted ways with Spain, which it currently subsidises by paying more in taxes than it receives in government spending, it would nonetheless remain within the single market. That makes independence a much easier sell.

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The Atlantic: Can a Nation’s Soil Explain Its Economic Fortunes?

Post author By Margaret Allen
Post date September 18, 2014

If your ancestors could grow crops easily—and thus get proof that patience pays off—you’re more likely to value distant payoffs, argue two economists in a new paper.

Journalist Joe Pinsker with The Atlantic covered the research of SMU economist Ömer Özak about the association between cultures that value long-term payoffs and their ancient history of successful crop yields. Pinsker’s story, “Can a Nation’s Soil Explain Its Economic Fortunes?” published Sept. 17. Özak’s co-author on the study was economist Oded Galor, Brown University.

Özak, an assistant professor in the SMU Department of Economics, is an expert in technological change and economic growth, macroeconomics and monetary economics and international economics. For more about Özak’s research and teaching philosophy, see his web site at ÖmerÖzak.com.

Özak’s research focuses on technological change and economic growth, macroeconomics and monetary economics and international economics.

In particular, Özak’s research explores the role of geography, technology and culture on contemporaneous economic development. He additionally has explored the relationship between market imperfections and technological innovation and adoption. His research also examines the dynamics of economies with heterogeneous interacting agents. Özak has published books and articles on economic growth, mathematics, game theory, monetary theory and the history of economic thought.

Read The Atlantic story.

EXCERPT:

By Joe Pinsker
The Atlantic
Jared Diamond argued, in his 1997 book Guns, Germs, and Steel, that geography is fate. One thread of his theory sought to explain why societies in Eurasia developed more quickly than in the Americas and Africa. Because Eurasia is oriented horizontally, he argued, all of its ancient inhabitants were at roughly similar latitudes, which meant that they worked with roughly similar environments and climates. Thus, a particularly valuable crop or domesticated animal could be put to use just about anywhere on the continent, and one group’s best practices could easily be adopted by other groups—not the case in vertical Africa. Hence, different rates of development.

Two economics researchers, Brown’s Oded Galor and Southern Methodist University’s Ömer Özak, recently published an ambitious paper reminiscent of Diamond’s work. Like Diamond, they make an argument that is so simple and intuitive that it at first glance appears reductive: People whose ancestors come from places with richer harvests are more likely to appreciate the benefits of long-term thinking. Essentially, the theory suggests that because people who lived in especially fertile areas had more reason to believe that patience pays off, they came to create cultures that are okay with delaying gratification.

Galor and Özak’s thinking, while data-driven, mostly yields abstract conclusions: The higher the crop yield, the more patient people will be, and the more patient people are, the more dependably their economies will grow. However, the pair’s findings are occasionally quite concrete: Modern-day countries that, roughly 500 years ago, had crop yields one standard deviation higher than average build roughly one year of extra schooling into their education systems. In other words, if wheat was really shooting up for your ancestors 500 years ago, then you’re more likely to have had 12 years of schooling instead of 11.

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Dallas Morning News: Study: Mild winter, wet spring to blame for Dallas County’s deadly West Nile outbreak

Post author By Margaret Allen
Post date July 17, 2013

A plane flew over central Dallas as part of aerial spraying efforts last summer to combat mosquitoes carrying the West Nile virus. (Credit: Dallas Morning News)

The Dallas Morning News covered the research of SMU economist Thomas B. Fomby and SMU Dedman College Distinguished Alumnus Robert W. Haley, who co-authored a new study on West Nile Virus.

Fomby and Haley, along with other researchers, analyzed a decade of data related to West Nile Virus and, in particular, the 2012 West Nile epidemic in Dallas County. The analysis allowed them to identify important precursors of West Nile Virus outbreaks that allow for early and effective intervention.

Fomby, a data modeling expert, is a professor of Economics and director of the Richard B. Johnson Center for Economic Studies at SMU.

Haley is chief of Epidemiology and professor of Internal Medicine at UT Southwestern. Other authors of the study were physician Wendy Chung, chief epidemiologist, and her associates Christen Buseman, Sibeso Joyner and Sonya Hughes, all of Dallas County Health and Human Services; and James Luby, professor of internal medicine in the Division of Infectious Diseases at UT Southwestern.

They reported the findings in the July 17 issue of The Journal of the American Medical Association.

Their analysis of the West Nile data, along with weather and housing data, found that the epidemics begin early, after unusually warm winters; are often in similar geographical locations; and are predicted by an index based on an estimate of the average number of West Nile virus-infected mosquitoes collected per trap-night, called the Mosquito Vector Index.

As a result of their data analysis, the researchers recommend the use of a vector-index rating system to identify the best timing and location of early interventions.

Read the full story.

EXCERPT:
By Sherry Jacobson
Dallas Morning News

An in-depth study of last year’s West Nile epidemic in Dallas County blames a mild winter, wet spring and an abundance of mosquitoes for spreading the sometimes-fatal virus.

But local officials did not realize how quickly the mosquito-borne outbreak was unfolding. If they had recognized the signs earlier, 110 severe human infections might have been prevented and a dozen lives saved, the study said.

“It’s a very optimistic estimate and might not be totally realistic,” said Dr. Robert Haley, one of the authors of the study published Wednesday in the Journal of the American Medical Association.

His estimate was based on the possibility that officials could have resorted to aerial spraying of insecticides in early July, instead of a month later. It also supposed that spraying could have halted the West Nile outbreak.

The study suggested a deadly equation was at work: Five percent of the Culex mosquitoes were carrying the West Nile virus by late June. At that point, the disease was spreading quickly, but no one knew it.

While the conclusions are purely hindsight, the study could provide valuable information to help prevent future West Nile outbreaks, said Haley, chief epidemiologist at UT Southwestern Medical Center.

“This could be a breakthrough for how to track a West Nile outbreak,” he said. “For a small amount of data, this study is remarkably strong.”

The study grew out of the worst West Nile outbreak in Texas history. More than 400 Dallas County residents suffered mild to severe symptoms of the neuroinvasive disease and 20 died.

All were bitten by infected mosquitoes despite widespread warnings and ground spraying of insecticide. But no one could explain why it happened.

Dr. Wendy Chung, the study’s lead author, said researchers looked for answers in a massive amount of West Nile data collected last year by government agencies.

The study focused on infected mosquitoes and how quickly they passed the virus to humans. It also considered the locations where people were infected and if weather patterns might have accelerated the outbreak.

“Weather that predisposes us to have a bad West Nile season is considered one of the soft indicators” of an impending outbreak, said Chung, chief epidemiologist for Dallas County Health and Human Services. “You can have bad weather and not have a bad season.”

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Tags Dedman College, Robert W. Haley, SMU Department of Economics, Thomas B. Fomby

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Mosquito indexing system identifies best time to act against potential West Nile Virus outbreaks

Post author By Margaret Allen
Post date July 16, 2013

Study examines characteristics, features of West Nile virus outbreaks from Dallas County housing, hospital and weather data

Larvae of Culex Mosquitoes make dense groups in standing water. (Credit: James Gathany, CDC)

Researchers who analyzed a decade of data related to West Nile Virus and, in particular, the 2012 West Nile epidemic in Dallas County, have identified important precursors of West Nile Virus outbreaks that allow for early and effective intervention.

An analysis of the West Nile data, along with weather and housing data, found that the epidemics begin early, after unusually warm winters; are often in similar geographical locations; and are predicted by an index based on an estimate of the average number of West Nile virus-infected mosquitoes collected per trap-night, called the Mosquito Vector Index.

As a result of their data analysis, the researchers recommend the use of a vector-index rating system to identify the best timing and location of early interventions.

The researchers, from Southern Methodist University, UT Southwestern Medical Center and Dallas County Health and Human Services, reported the findings in the July 17 issue of The Journal of the American Medical Association.

The analysis revealed a mosquito vector index rating of 0.5 in June or July as the best time to act to avoid an outbreak and stave off the resultant rise in human West Nile infections, which can cause long-term neurological damage and even death.

“In years when the vector index didn’t start up until late July or August, impending outbreaks just sputtered — in late summer mosquito abundance declines and mosquitoes become less active and stop biting as much. When the vector index goes above .5 early — June or July — right then large numbers of people are silently getting infected, and this should be the best time to intervene,” said senior author Robert W. Haley, Chief of Epidemiology and Professor of Internal Medicine at UT Southwestern.

“After the infecting mosquito bite, on average it takes a week for the first symptoms to develop, a week to see people turning up at hospitals, and a week for laboratory confirmation of the diagnosis and reporting to health officials,” Haley said. “That three weeks is critical. Acting early from the vector index rather than after human case reports and deaths mount up can nip an outbreak in the bud. However, if mosquito data are unavailable or consensus to intervene takes longer, later intervention may still be important to terminate the outbreak.”

The analysis found also that less of a hard freeze during winter months and unusually warm spring temperatures contributed to epidemic years for West Nile, a major concern as global temperatures continue to warm, Haley said.

A fourth critical finding in the paper related census track data to the 2012 outbreak, showing that areas of higher property values, higher housing density, and higher percentages of unoccupied homes were at higher risk. That’s likely due to fostering the types of environment and mosquitos most likely to transmit the disease, which is carried more by house mosquitoes than wooded mosquitoes. In Dallas County, the data showed year-after-year clustering in the Park Cities and North Dallas areas.

Study authors supply instruction manual for other counties
The analysis tools used in the study may be applicable elsewhere, but due to variations in weather, mosquito populations and other factors, each region or county will need to conduct its own analysis to identify the most appropriate vector index rating signaling when to act, Haley said. Along with the paper, the authors provide an instruction manual for other counties to calculate the vector index from their own mosquito infection surveillance data.

“Given the leading character of this index, epidemiologists and government officials can implement, in a more timely manner, preventative measures to reduce the impact of future West Nile Virus outbreaks,” said data modeling expert Thomas B. Fomby, Professor of Economics and the Director of the Richard B. Johnson Center for Economic Studies at SMU.

Fomby provided the time series expertise needed to analyze the leading nature of the vector index and determine that aerial spraying used during the epidemic did not have any significant adverse health effects on the general public.

“Time Series Count modeling and Event Analysis are statistical methods that are frequently used in economic research but not so often used in medical research,” Fomby said. “Time Series Count modeling was used to investigate the leading nature of the vector index while Event Analysis was used to examine the impacts of aerial spraying. This is a prime example of where interdisciplinary tools can be useful in conducting scientific research.”

Other authors of the study were physician Wendy Chung, Chief Epidemiologist, and her associates Christen Buseman, Sibeso Joyner and Sonya Hughes, all of Dallas County Health and Human Services; and James Luby, professor of internal medicine in the Division of Infectious Diseases at UT Southwestern.

West Nile virus first identified in Dallas County in 2002
“After declining over the prior 5 years, mosquito-borne West Nile virus infection resurged in 2012 throughout the United States, most substantially in Dallas County, Texas. Dallas has been a known focus of mosquito-borne encephalitis since 1966, when a large epidemic of St. Louis encephalitis (SLE) occurred there, necessitating aerial spraying of insecticide for control,” according to background information in the article.

“With the introduction of West Nile virus into New York City in 1999 and its subsequent spread across the country, West Nile virus appears to have displaced SLE virus,” the authors wrote. “Dallas recognized its initial cases of West Nile virus encephalitis in 2002 and its first sizeable outbreak in 2006, followed by 5 years of low West Nile virus activity. In the 2012 nationwide West Nile virus resurgence, Dallas County experienced the most West Nile virus infections of any U.S. urban area, requiring intensified ground and aerial spraying of insecticides.”

Study analyzed multitude of data, from infections to weather to geography
The study examined the features associated with the West Nile virus epidemics to identify surveillance and control measures for minimizing future outbreaks.

The researchers analyzed surveillance data from Dallas County (population, 2.4 million), which included the numbers of residents diagnosed with West Nile virus infection between May 30, 2012 and Dec. 3, 2012; mosquito trap results; weather data; and syndromic (pertaining to symptoms and syndromes) surveillance from area emergency departments.

From May 30 through Dec. 3, 2012, patients with any West Nile virus-positive test result were reported to the health department; 615 met laboratory case criteria, and 398 cases of West Nile virus illness with 19 deaths were confirmed by clinical review in residents of Dallas County.

The outbreak included 173 patients with West Nile neuroinvasive disease (WNND) and 225 with West Nile fever, and 17 West Nile virus-positive blood donors. Regarding patients with WNND, 96 percent were hospitalized; 35 percent required intensive care; 18 percent required assisted ventilation; and the case-fatality rate was 10 percent. The overall WNND incidence rate in Dallas County was 7.30 per 100,000 residents in 20l2, compared with 2.91 in 2006.

The first West Nile virus-positive mosquito pool of 2012 was detected in late May, earlier than in typical seasons. Symptoms of the first 19 cases of WNND in 2012 began in June, a month earlier than in most prior seasons; thereafter, the number of new cases escalated rapidly. Sequential increases in the weekly vector index early in the 2012 season significantly predicted the number of patients with onset of symptoms of WNND in the subsequent l to 2 weeks.

West Nile neuroinvasive disease clustered in neighborhoods with high housing density
The 2012 epidemic year was distinguished from the preceding 10 years by the mildest winter, as indicated by absence of hard winter freezes, the most degree-days above daily normal temperature during the winter and spring and other features. During the 11 years since West Nile virus was first identified in Dallas, the researchers found that the annual prevalence of WNND was inversely associated with the number of days with low temperatures below 28 degrees Fahrenheit in December through February.

“Although initially widely distributed, WNND cases soon clustered in neighborhoods with high housing density in the north central area of the county, reflecting higher vector indices and following geospatial patterns of West Nile virus in prior years,” the authors write.

Aerial insecticide spraying was not associated with increases in emergency department visits for respiratory symptoms or skin rash.

“This report identifies several distinguishing features of a large urban West Nile virus outbreak that may assist future prevention and control efforts for vector-borne infections,” the authors write. “Consideration of weather patterns and historical geographical hot spots and acting on the vector index may help prevent West Nile virus-associated illness.” — UT Southwestern, JAMA, SMU

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Tags Dedman College, Robert W. Haley, SMU Department of Economics, Thomas B. Fomby

“This is a really exciting area of research where game theory based models can provide direct insights into behavior of market participants.” — Roy

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The size and homogeneity of a country’s population has a big bearing on its economic policies

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If your ancestors could grow crops easily—and thus get proof that patience pays off—you’re more likely to value distant payoffs, argue two economists in a new paper.

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Study examines characteristics, features of West Nile virus outbreaks from Dallas County housing, hospital and weather data

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