Essays in industrial organization

The motivation of this thesis is the study of markets in which consumers are under-informed concerning the quality of any given product and in which the quality of consumers also matters to producers of products. This study has resulted in a primary application paper, comprising the first chapter which focuses on the market for training lawyers, as well as a second technical chapter exploring theory which can prove useful in analyzing these markets. The first chapter is based on the observation that the number of lawyers being produced at high cost combined with the relative lack of job options has recently created significant concern. In order to partially explain this phenomenon, I propose a game of incomplete information modeling the strategic interaction between law schools as they compete for potential students. The information asymmetries come from the fact that any given law school is better informed about the quality of its education than its potential students. Using a change in market information structure generated by student placement reporting requirements, I use the model to estimate the dynamic effect of increased information on distributions of tuition rates, incoming student ability, class sizes, and the rate at which law schools open and potentially close. Using these estimates, I show that there have not necessarily been too many law schools or students, but rather an equilibrium enforced mismatch between students and their optimal schooling choices. The new information has acted as a forced collusion mechanism to partially overcome this mismatch, which has differentially decreased school welfare, strictly increased student welfare, and resulted in a positive total welfare gain of $685 million. The second chapter provides a thorough exploration of the microeconomic foundations for the multi-variate linear demand function for differentiated products that is widely used in industrial organization. A key finding is that strict concavity of the quadratic utility function is critical for the demand system to be well defined. Otherwise, the true demand function may be quite complex: Multi-valued, non-linear and income-dependent. The solution of the first order conditions for the consumer problem, which we call a local demand function, may have quite pathological properties. We uncover failures of duality relationships between substitute products and complementary products, as well as the incompatibility between high levels of complementarity and concavity. The two-good case emerges as a special case with strong but non-robust properties. A key implication is that all conclusions derived via the use of linear demand that does not satisfy the law of Demand ought to be regarded with some suspicion.