Equilibrium Transition from Loss-Leader Competition: How Advertising Restrictions Facilitate Price Coordination in Chilean Pharmaceutical Retail

Yu and Hao
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Yu: Jasmine

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Abstract: Between December 2007 and April 2008 Chile's three retail pharmacy chains coordinated price increases on 222 medicines, weeks after advertising restrictions ended the comparative-price war that drove prices below cost. I study the transition with a demand-grounded structural model. The mechanism has two parts. Store traffic: comparative-price ads broadcast who is cheapest, so undercutting pays, yielding a below-cost war. Belief: a coordinated increase holds only if rivals expect it matched. The advertising ban moves both: by collapsing price sensitivity it makes undercutting unprofitable for the inelastic majority of drugs, so the coordinated price becomes a static best response, and as a public event it shifts beliefs, releasing the wave. A dynamic model estimated by simulated method of moments reproduces the path--the war, the failed attempts, and the post-ban coordination. The harm is distributional: a transfer to supra-competitive rents, with small deadweight loss because post-ban demand is inelastic.

Date: 2025-12, Revised 2026-06
New Economics Papers: this item is included in nep-ind and nep-reg
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