In this article, I develop and estimate a model of dynamic consumer behavior with switching costs in the market for paid-television services. I estimate the parameters of the structural model using data on cable and satellite systems across local US television markets over the period 1992-2006. The results suggest switching costs range from $159 to $242 for cable and from $212 to $276 for satellite providers in 1997 dollars. Using a simple dynamic model of cable providers, I demonstrate that switching costs of these magnitudes can significantly affect the firms' optimal strategies. * University of Mannheim; ashcherb@mail.uni-mannheim.de. I am deeply indebted to my supervisors, Gregory Crawford and Gautam Gowrisankaran, for their help at all stages of my work. I greatly acknowledge valuable advice and suggestions made by Daniel Ackerberg, Keisuke Hirano, and Aviv Nevo. Useful comments and suggestions made by Kathleen Nosal, Yuya Takahashi, Tim Lee, Nicolas Schutz, Philipp Schmidt-Dengler, and anonymous referees are greatly appreciated. All errors are my own. 366 C 2016, The RAND Corporation. 1 In 2007, cable operators had revenues of about $79.1 billion nationwide. 2 The methodology can be applied to other industries as well. For example, Nosal (2012) extends the method to estimate consumer switching costs in the health insurance industry. C The RAND Corporation 2016. Television industry: institutional detailsCable television originated in the late 1940s as a means of delivering broadcast signals to areas with poor over-the-air reception. It diffused widely in the 1970s, when television networks began using satellite technology to deliver their content to cable systems. Until the early 1990s, when a Direct Broadcast Satellite (DBS) service was launched, local cable systems were natural monopolies. Since then, the subscriber base of DBS providers has experienced rapid growth. Competition in the television industry between DBS and cable operators is somewhat unusual because cable systems make pricing and quality decisions locally, whereas satellite policies are set at the national level. In 1996, the Telecommunications Act removed price controls on highquality products, leaving only basic service subject to (possibly very weak) regulation. So-called must-carry regulations sometimes require cable systems to provide certain television stations in C The RAND Corporation 2016.

We measure the welfare consequences of endogenous quality choice in imperfectly competitive markets. We introduce the concept of a "quality markup" and measure the relative importance for welfare of market power over price versus market power over quality. For U.S. cable-television markets between 1997-2006, we find that prices are 33% to 74% higher and qualities 23% to 55% higher than socially optimal. This "quality inflation" contradicts classic results in the literature and reflects our flexible specification of consumer preferences. Furthermore, we find market power over quality is responsible for 54% of the total welfare change from endogenous prices and qualities.

No abstract

We measure the welfare distortions from endogenous quality choice in imperfectly competitive markets. For US cable television markets between 1997-2006, prices are 33 percent to 74 percent higher and qualities 23 percent to 55 percent higher than socially optimal. Such quality overprovision contradicts classic results in the literature and our analysis shows that it results from the presence of competition from high-end satellite TV providers: without the competitive pressure from satellite companies, cable TV monopolists would instead engage in quality degradation. For welfare, quality overprovision implies cable customers would prefer smaller, lower-quality cable bundles at a lower price, amounting to a twofold increase in consumer surplus for the average consumer. (JEL L13, L15, L82)

We measure the welfare distortions from endogenous quality choice in imperfectly competitive markets. For US cable television markets between 1997-2006, prices are 33 percent to 74 percent higher and qualities 23 percent to 55 percent higher than socially optimal. Such quality overprovision contradicts classic results in the literature and our analysis shows that it results from the presence of competition from high-end satellite TV providers: without the competitive pressure from satellite companies, cable TV monopolists would instead engage in quality degradation. For welfare, quality overprovision implies cable customers would prefer smaller, lower-quality cable bundles at a lower price, amounting to a twofold increase in consumer surplus for the average consumer. (JEL L13, L15, L82)