Bundling Information Goods Under Endogenous Quality Choice

Abstract

Using the cable industry as an illustrative case, this article investigates implications of endogenous quality choice when bundling information goods and analyzes welfare effects of an a la carte regulation that forces firms to unbundle products. The analysis shows that a la carte pricing decreases consumer surplus and product quality even when it reduces the average product price. An increase in advertising rates decreases product price, but it also reduces product quality and could make consumers worse off. These findings have important policy implications for media markets where regulators are considering imposition of a la carte pricing.

Notes

Nodir Adilov is an Assistant Professor in the Department of Economics at the Richard T. Doermer School of Business at Indiana University–Purdue University, Fort Wayne, United States.

¹See Adams and Yellen (1976); Bakos and Brynjolfsson (1999, 2000); McAfee, McMillan, and Whinston (1989); Salinger (1995); and Schmalensee (1984).

²See Gabel and Kennet (1994) for empirical evidence on economies of scope in the telephone market.

³See Nalebuff (2004).

⁴A recent empirical study by Crawford (2008) strongly supports the argument that consumer sorting plays an important role for a cable operator's decision to bundle television programs.

⁵See Consumer Federation of America and Consumers Union (2004).

⁶See National Cable & Telecommunications Association (2004) and Eisenach and Ludwick (2006).

⁷See, for example, Adams and Yellen (1976), Bakos and Brynjolfsson (1999, 2000), Rennhoff and Serfes (2009), Salinger (1995), and Schmalensee (1984) for traditional approaches to model product bundling in media markets.

⁸Note that the second-order conditions are satisfied because the profit function (π) is strictly concave with respect to price levels: θ²π/θp ² _i = −2/f(e_i ) < 0 and θ²π/θp_i θp_j = 0.

⁹The second-order conditions are satisfied because θ²π/θe ² _i = f″(e_i )/4 < 0 and θ²π/θe ₁θe_j = 0.

¹⁰Using the conventional notation, “iff” denotes “if and only if.”

¹¹Note that the second-order condition is satisfied because θ²π/θp ² _B = −6p_B /2x ₁ x ₂ < 0.

¹²Again, the second-order condition is satisfied because the profit function is concave with respect to p_B .

¹³Note that the firm's revenue function q_Bp_B can be calculated using Equations A7 and A8.

¹⁴The second-order conditions are satisfied because the profit function is concave.