Bundling Effects on Welfare in the Pay Tv Market

1. Introduction
Bundling is a common feature in many imperfectly competitive product markets. Firms in the telecommunications, financial services, health care, and information industries frequently offer products in bundles. While often innocuous, recent research has identified settings in which bundling can be used by firms to price discriminate among consumers or to extend market power into related product markets ([Adams and Yellen, 1976], [Bakos and Brynjolfsson, 1999] and [Nalebuff, 2004]).

We conduct a numerical analysis of bundling’s impact on the prices and networks offered by a “typical” US cable television system and assess the consequences of these choices for consumer, producer, and total welfare. We do so to speak to the current public policy debate about bundling in cable markets. Motivated by consumer dis-satisfaction over ever-increasing cable prices, law- and policy-makers are looking at unbundling – or “à la carte” pricing – as a possible policy solution.1 Most cable television systems and the networks provided on them are strongly opposed to the idea, in part claiming that doing so would (possibly dramatically) reduce the number of (especially smaller) networks that can survive in an à la carte environment (Booz Allen Hamilton, 2004).2

Existing theory bears out both of these views. On bundling and pricing, a substantial theoretical literature suggests that bundling may be used to sort consumers in a manner similar to second-degree price discrimination ([Stigler, 1968], [Adams and Yellen, 1976], [McAfee et al., 1989], [Bakos and Brynjolfsson, 1999] and [Armstrong, 1999]). When consumers have heterogeneous tastes for several products, bundling reduces that heterogeneity, allowing the firm to earn greater profit than would be possible with component (unbundled) prices. While firms clearly benefit in this case, consumer welfare generally falls, particularly when bundling requires consumers to purchase products in which they have little... [continues]

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