Michael Baye

Michael Baye is the Bert Elwert Professor of Business at Indiana University’s Kelley School of Business. He served as the

Areas of Expertise

Industrial Organization, Microeconomics, Game Theory, E-Commerce, Antitrust

Academic Degrees

• PhD, Purdue University, 1983
• MS, Purdue University, 1981
• BS, Texas A&M University, 1980

Professional Experience

• Bert Elwert Professor of Business, Kelley School of Business, Indiana University, 1997-present
• Director, Bureau of Economics, Federal Trade Commission, 2007-2008

Awards, Honors & Certificates

• Outstanding Researcher, Kelley School of Business, 1999-2000; 2003-2004, 2009-2010
• Teaching Excellence Award, Kelley School of Business, 1997-1998; 1998-1999; 1999-2000

Selected Publications

• Michael R. Baye and Jeffrey T. Prince (2017), Managerial Economics and Business Strategy (9th Edition), McGraw-Hill.
• An, Yonghong, Michael R. Baye, Yingyao Hu, John Morgan and Matt Shum (2017), "Identification and Estimation of Online Price Competition With an Unknown Number of Firms," Journal of Applied Economics, 32(1): 80-102.
• Baye, Michael R., Babur De los Santos, and Matthijs R.Wildenbeest (2016), “Search Engine Optimization: What Drives Organic Traffic to Retail Sites?” Journal of Economics & Management Strategy, 25(1): 6-31.
• Baye, Michael R., Babur De los Santos, and Matthijs R. Wildenbeest (2016), "What''s in a Name? Measuring Prominence, and Its Impact on Organic Traffic from Search Engines," Information Economics and Policy, 34: 44-57.
• Baye, Michael R., Babur De Los Santos and Matthijs R. Wildenbeest (2013), "Searching for Physical and Digital Media: The Evolution of Platforms for Finding Books," NBER''s Economics of Digitization, ed. by S. Greenstein, A. Goldfarb, and C. Tucker. University of Chicago Press, 137-165.

Abstract This chapter provides a data-driven overview of the dierent online platforms that consumers use to search for books and booksellers, and documents how the use of these platforms is shifting over time. Our data suggest that, as a result of digitization, consumers are increasingly conducting searches for books at retailer sites and closed systems (e.g., the Kindle and Nook) rather than at general search engines (e.g., Google or Bing). We also highlight a number of challenges that will make it dicult for researchers to accurately measure internet-based search behavior in the years to come. Finally, we highlight a number of open agenda items related to the pricing of books and other digital media, as well as consumer search behavior.

• De los Santos, Babur I., Michael R. Baye, and Matthijs Wildenbeest (2013), "The Evolution of Product Search," Journal of Law, Economics & Policy, 9:2, 201-221.
• Baye, Michael R., Dan Kovenock, and Casper G. de Vries (2012), “The Herodotus Paradox,” Games and Economic Behavior, Vol. 74, pp. 399-406.  

Abstract The Babylonian bridal auction, described by Herodotus, is regarded as one of the earliest uses of an auction in history. Yet, to our knowledge, the literature lacks a formal equilibrium analysis of this auction. We provide such an analysis for the two-player case with complete and incomplete information, and in so doing identify what we call the “Herodotus Paradox.”

• Michael R. Baye, Dan Kovenock, and Casper G. de Vries, “Contests with Rank-Order Spillovers,” Economic Theory, Vol. 51 (2012), pp. 315-350.

Abstract This paper presents a unified framework for characterizing symmetric equilibrium in simultaneous move, two-player, rank-order contests with complete information, in which each player’s strategy generates direct or indirect affine “spillover” effects that depend on the rank-order of her decision variable. These effects arise in natural interpretations of a number of important economic environments, as well as in classic contests adapted to recent experimental and behavioral models where individuals exhibit inequality aversion or regret. We provide the closed-form solution for the symmetric Nash equilibria of this class of games, and show how it can be used to directly solve for equilibrium behavior in auctions, pricing games, tournaments, R&D races, models of litigation, and a host of other contests.

• Michael R. Baye and Joshua D. Wright, “Is Antitrust Too Complicated for Generalist Judges? The Impact of Economic Complexity and Judicial Training on Appeals,” Journal of Law and Economics, Vol. 54, No. 1 (February 2011), pp. 1-24.

Abstract The recent increase in the demand for expert economic analysis in antitrust litigation has improved the welfare of economists; however, the law and economics literature is silent on the effects of economic complexity or judges’ economic training on judicial decision-making. We use a unique data set on antitrust litigation in federal district and administrative courts during 1996-2006 to examine whether economic complexity impacts antitrust decisions, and provide a novel test of the hypothesis that antitrust analysis has become too complex for generalist judges. We also examine the impact of basic economic training by judges. We find that decisions involving the evaluation of complex economic evidence are significantly more likely to be appealed, and decisions of judges trained in basic economics are significantly less likely to be appealed than are decisions by their untrained counterparts. Our analysis supports the hypothesis that some antitrust cases are too complicated for generalist judges. 

• Baye, Michael R., Xiaxun Gao, and John Morgan, “On the Optimality of Clickthrough Fees in Online Markets,” Economic Journal, Vol. 121, (November 2011), pp. 340-367.

Abstract We study optimal fee setting decisions by a monopoly online platform connecting advertisers with potential buyers in two environments: a simple model that captures stylised features of advertising on search engines, social networks and advertisement-supported email; and a richer model that is more relevant for ‘directed’ search at price comparison sites. While the platform can choose to charge for both impressions and clicks, we show that the platform maximises profits by using clickthrough fees exclusively. Our model offers a rationale for the evolving practice of relying purely on clickthrough fees for revenues in many online advertising markets. The pricing of online advertising has undergone a sea change since its early days. The dominant old media model of paying per impression, the so-called CPM (cost per impression) model, has given way to a pricing model where most payments are made contingent on the viewer taking some action, typically clicking on the advertisement.1 This is the so-called CPC (cost per click) model of pricing. In this article, we investigate why platforms such as price comparison sites have shifted from CPM to CPC.This change is usually seen as a response to pressure from advertisers worried about the performance of the new online media. Under the CPC model, an advertiser only pays when an advertisement is effective – based on the user action of clicking. Thus, the risk of performance is shifted from the advertiser to the site displaying the advertisements. While there is little doubt that advertisers were (and still are) sceptical about the returns to online advertising, this article points out an additional motivation for the shift: the platform hosting advertising content – what Baye and Morgan (2001) have previously dubbed the ‘information gatekeeper’– also stands to benefit from this pricing arrangement. Indeed, our main result is that, when CPC and CPM are both available and can be used jointly as pricing instruments, the platform maximises its profits by using CPC exclusively.One might speculate that the CPC and CPM instruments are analogous to two-part tariffs for a standard monopoly: price at marginal cost and use a fixed fee to extract surplus from advertisers. Under this logic, one might erroneously conclude that the gatekeeper should optimally set the clickthrough fee at zero (its marginal cost) and use an impression fee to extract surplus from potential advertisers.2 Where this logic goes wrong is that it ignores competition among advertisers. In the standard setting, one buyer''s decision to accept the monopolist''s offer does not impact the valuations of other buyers. In the present setting, one firm''s decision to have its advertisement displayed does impact the amount other firms are willing to pay, as it reduces the likelihood that their advertisements will be viewed as ‘best’ and hence clicked by consumers. An optimising platform takes this ‘competition for clicks’ into account in its pricing, and this makes the analysis of the optimal fee structure more complex than in the standard textbook case.The trade-offs between CPC and CPM can be clearly seen in the simple model of optimal platform pricing presented in Section 1, where advertisements exogenously differ in their attractiveness and relevance to consumers. As consumers click on the most attractive and relevant advertisement, a less attractive advertiser might still hope to obtain clicks via relevance. Advertisers enter until the least attractive (marginal) advertiser is just indifferent between utilising this channel or earning zero from its outside option.Suppose that impression and clickthrough fees are adjusted to maintain the same number of advertisers. Then a $1 increase in the clickthrough fee requires a reduction in the impression fee in proportion to the chance that no other firm''s advertisement is displayed, i.e. an order statistic. The platform benefits from such an adjustment in proportion to the chance that at least one firm''s advertisement is displayed (i.e. deemed relevant by its algorithm) since otherwise the platform gets no clickthrough revenues. It is harmed by the reduction in impression revenues from all firms. The heart of the argument is establishing that this decrease is proportional to the chance that at least one firm''s advertisement is displayed. As the former probability always exceeds the latter, a greater reliance on clickthrough fees raises platform profits and hence the exclusive use of clickthrough fees is optimal (Proposition 1). Put differently, while clickthrough fees operate on an order statistic – only the most attractive relevant firm pays – impression fees affect all firms and hence are a blunter instrument for extracting surplus. Of course, once clickthrough fees are used exclusively, they have the same effect as a reserve price in an auction. Proposition 2 shows how the platform optimally adjusts the clickthrough fee to induce the profit maximising number of advertisers.While the simple model is a clean illustration of this intuition, one may worry that the result may be altered or reversed when the attractiveness of advertisements or the value of the outside option is endogenised. To investigate this possibility, Section 2 considers a richer model in the spirit of Baye and Morgan (2001), the first study to examine the fee-setting behaviour of a ‘gatekeeper’ serving consumers and firms in a two-sided online market. This model closely corresponds to a setting where the platform is a price comparison site.3 The price charged by a firm determines the attractiveness of its advertisement, while the firm''s outside option (i.e. the payoff when not using the site) depends on the intensity of advertising at the site. Thus, both the attractiveness of advertisements and the value of eschewing the platform''s channel are endogenous.Despite these modelling differences, CPC remains the superior instrument for capturing surplus in the market (Proposition 3). Once again, the key driver is the fact that shoppers click on the best of the listed advertisements. Consequently, a firm realises that it is obliged to pay a clickthrough fee only if, ex post, its advertisement best matches the preferences of shoppers visiting the gatekeeper''s site. By contrast, an advertiser pays the impression fee regardless of whether it generates any clicks and before any information is revealed about whether its advertisement is ‘best’. Finally, the gatekeeper''s expected profits from the impression fee depend on the average number of advertisements induced by the fee, whereas its profits from clickthrough fees depend only on the probability that at least one firm advertises (an order statistic). The contingent nature of clickthrough fees, coupled with this order statistic effect, makes them a superior instrument for extracting surplus from potential advertisers. These results obtain in a model where firms are ex ante symmetric and there is no moral hazard. Obviously, if firms were vulnerable to opportunistic behaviour on the part of the gatekeeper – displaying advertisements to consumers it knows are not interested in purchasing a firm''s product, for instance – the superiority of clickthrough fees over impression fees would be even greater.The institutional structure of the richer model also allows us to study other features of online markets. Conversion rates, the chance that clicks are converted into sales, play a key role. We show that, while the exclusive use of clickthrough fees is optimal for any positive conversion rate, higher conversion rates lead to higher clickthrough fees and higher profits for the gatekeeper. Firms also benefit from higher conversion rates. An important insight to emerge from this analysis is that the platform only partly captures the gains from its investment in improving conversions. Thus, platforms will tend to underinvest in improvements. This perhaps helps to explain why conversions remain stubbornly low (about 5% at most) on these sites.Although both models share the same implication about the optimality of CPC pricing, Section 3 shows that there are important differences. Both models assume that there are (potentially small) transactions costs to firms wishing to advertise on the platform. In the simple model, platform profits increase continuously as transactions costs fall to zero. In the richer model, the outside option is endogenous and this leads to a discontinuity in payoffs – platform profits exhibit an upward jump when transactions costs are eliminated. In a similar vein, exclusive contracts (i.e. contracts that offer a single advertiser the exclusive right to advertise on the platform) are of no benefit to the platform in the simple model but are potentially helpful in the richer model.Our article is related to the literature on optimal fee structures in two-sided markets when there is a monopoly platform.4 An important difference is that payoffs in these models are increasing in the number of agents on the opposite side of the platform and independent of the number of agents on the same side of the platform. In other words, competition among users on the same side of the platform is effectively absent. In the settings we study, it is natural to include competition among advertisers, and this is the key driver of the optimality of clickthrough fees over impression fees. Indeed, our analysis suggests that existing results on the equivalence of impression fees and clickthrough fees – cf. Proposition 3 in Armstrong (2006) as well as Proposition 3 in Eliaz and Spiegler (2011)– stem from the absence of user (i.e. advertiser) competition.Our article is somewhat related to the literature on position auctions (Edelman and Schwarz, 2006; Edelman et al., 2007; Varian, 2007; Athey and Ellison, forthcoming). While these models also study clickthrough fees, their levels are determined by the auction form selected by the platform. Seller decisions in these models consist purely of how much to bid in the position auction.Like many of these models, our model assumes that there is a single dominant platform in the market. While this potentially limits the applicability of these models, casual empiricism suggests that such market structures are, in fact, common. For instance, eBay is the dominant platform for online auctions in the US; Google enjoys overwhelming market share in search; Facebook is the dominant social networking platform. A burgeoning empirical literature (Liebowitz and Margolis, 1994; Brown and Morgan, 2009; Tellis et al., 2009) documents that single (dominant) platforms are the rule in many markets. Recent experimental evidence (Hossain and Morgan, 2009; Hossain et al., forthcoming) paints a similar picture: unless platforms are strongly horizontally differentiated, the most likely market structure to emerge is a monopoly platform.

• Michael R. Baye and John Morgan, “Brand and Price Advertising in Online Markets,” Management Science, Vol. 55, No. 7 (July 2009), pp. 1139-1151.

Abstract We model an environment where e-retailers sell similar products and endogenously engage in both brand advertising (to create loyal customers) and price advertising (to attract "shoppers"). In contrast to models where loyalty is exogenous, endogenizing the creation of loyal customers by allowing firms to engage in brand advertising leads to a continuum of symmetric equilibria; however, there is a unique equilibrium in secure strategies, and the set of equilibria converges to this unique equilibrium as the number of potential e-retailers grows arbitrarily large. Price dispersion is a key feature of all of these equilibria, including the limit equilibrium. Branding tightens the range of prices and reduces the value of the price information provided by a comparison site, and this reduces profits for platforms (such as an Internet price comparison site) where firms advertise prices. Data from a leading price comparison site are shown to be consistent with several predictions of the model.

• Michael R. Baye,  J. Rupert Gatti, Paul Kattuman, and John Morgan, "Clicks, Discontinuities, and Firm Demand Online," Journal of Economics & Management Strategy, Vol. 18, No. 4 (Winter 2009), pp. 935-975.

Abstract We exploit a unique dataset from a price comparison site to estimate the determinants of clicks received by online retailers. We find that a firm enjoys a 60% jump in its clicks when it offers the lowest price at the site, and failure to account for discontinuities distorts parameter estimates by nearly 100%. This discontinuity is consistent with a variety of models that have been used to rationalize online price dispersion. Finally, we show that one may use estimates of the determinants of a firm''s clicks to obtain bounds on its underlying demand parameters, including standard elasticities of demand.

• Michael R. Baye, John Morgan, and Patrick Scholten, "Information, Search, and Price Dispersion," Chapter 6 in Handbook in Economics and Information Systems Volume 1 (T. Hendershott, Ed.), Amsterdam: Elsevier, 2006.

Abstract We provide a unified treatment of alternative models of information acquisition/transmission that have been advanced to rationalize price dispersion in online and offline markets for homogeneous products. These different frameworks -- which include sequential search, fixed sample search, and clearinghouse models -- reveal that reductions in (or the elimination of) consumer search costs need not reduce (or eliminate) price dispersion. Our treatment highlights a duality" between search-theoretic and clearinghouse models of dispersion, and shows how auction-theoretic tools may be used to simplify (and even generalize) existing theoretical results. We conclude with an overview of the burgeoning empirical literature. The empirical evidence suggests that price dispersion in both online and offline markets is sizeable, pervasive, and persistent and does not purely stem from subtle differences in firms'' products or services.

• Michael R. Baye, Dan Kovenock, and Casper G. de Vries, "Comparative Analysis of Litigation Systems: An Auction Theoretic Approach," Economic Journal, Vol. 115 (July 2005), pp. 583-601.

Abstract A simple auction-theoretic framework is used to examine symmetric litigation environments where the legal ownership of a disputed asset is unknown to the court. The court observes only the quality of the case presented by each party, and awards the asset to the party presenting the best case. Rational litigants influence the quality of their cases by hiring skilful attorneys. This framework permits us to compare the equilibrium legal expenditures that arise under a continuum of legal systems. The British rule, Continental rule, American rule, and some recently proposed legal reforms are special cases of our model.

• Michael R. Baye, John Morgan, and Patrick Scholten, “Price Dispersion in the Small and in the Large: Evidence from an Internet Price Comparison Site,” Journal of Industrial Economics, Vol. 52, No. 4 (December 2004), pp. 463-496. Winner of the Journal of Industrial Economics “Best Article Prize,” 2005.

Abstract This paper examines four million daily price observations for more than 1,000 consumer electronics products on the price comparison site http://Shopper.com. We find little support for the notion that prices on the Internet are converging to the ''law of one price.'' In addition, observed levels of price dispersion vary systematically with the number of firms listing prices. The difference between the two lowest prices (the ''gap'') averages 23 per cent when two firms list prices, and falls to 3.5 per cent in markets where 17 firms list prices. These empirical results are an implication of a general ''clearinghouse'' model of equilibrium price dispersion. 

• Maria Arbatskaya and Michael R. Baye, "Are Prices ''Sticky'' Online? Market Structure Effects and Asymmetric Responses to Cost Shocks in Online Mortgage Markets," International Journal of Industrial Organization, Vol. 22, No. 10 (2004), pp. 1443-1462. 

Abstract We analyze daily mortgage rates posted by online lenders at the price comparison site, Microsurf. While cost shocks occurred almost daily in our sample, quoted mortgage rates are surprisingly rigid: Only 16 percent of the posted rates represent changes. However, firms that adjusted rates in response to cost shocks did so quite rapidly; about 98 percent of a cost shock was passed through within two days of the cost shock. Duration analysis reveals that the observed rigidity in rates systematically depends on market structure: Online mortgage rates are 30 to 40 percent more durable in concentrated markets than in markets where there are many competitors. We also find that rates posted online tend to exhibit downward stickiness; rate adjustments in response to cost increases are about twice the corresponding adjustments for cost decreases.

• Michael R. Baye and John Morgan, "Price Dispersion in the Lab and on the Internet: Theory and Evidence," Rand Journal of Economics, Vol. 35, No. 3 (Autumn 2004), pp. 446-449.

Abstract Price dispersion is ubiquitous in settings that closely approximate textbook Bertrand competition. We show that only a little bounded rationality among sellers is needed to rationalize such dispersion. A variety of statistical tests, based on datasets from two independent laboratory experiments and structural estimates of the parameters of our models, suggest that bounded-rationality-based theories of price dispersion organize the data remarkably well. Evidence is also presented to suggest that the models are consistent with data from a leading Internet price comparison site.

• Michael R. Baye and Heidrun H. Hoppe, "The Strategic Equivalence of Rent-Seeking, Innovation, and Patent-Race Games," Games and Economic Behavior, Vol. 44 (2003), pp. 217-226.
• Michael R. Baye and John Morgan, "Winner-Take-All Price Competition," Economic Theory, Vol. 19 (2002), pp. 271-282.

Abstract We analyze an oligopoly model of homogeneous product price competition that allows for discontinuities in demand and/or costs. Conditions under which only zero profit equilibrium outcomes obtain in such settings are provided.We then illustrate through a series of examples that the conditions provided are “tight” in the sense that their relaxation leads to positive profit outcomes.

• Michael R. Baye and John Morgan, "Information Gatekeepers on the Internet and the Competitiveness of Homogeneous Product Markets," American Economic Review, Vol. 91, No. 3 (June 2001), pp. 454-474.

Abstract We examine the equilibrium interaction between a market for price information (controlled by a gatekeeper) and the homogenous product market it serves. The gatekeeper charges fees to firms that advertise prices on its Internet site and to consumers who access the list of advertised prices. Gatekeeper profits are maximized in an equilibrium where (a) the product market exhibits price dispersion; (b) access fees are sufficiently low that all consumers subscribe; (c) advertising fees exceed socially optimal levels, thus inducing partial firm participation; and (d) advertised prices are below unadvertised prices. Introducing the market for information has ambiguous social welfare effects.

• Michael R. Baye and Onsong Shin, “Strategic Behavior in Contests:  Comment,” American Economic Review, Vol. 89, No. 3 (June 1999), pp. 691-693.
•  Michael R. Baye, Dan Kovenock, and Casper G. de Vries, “The All-Pay Auction with Complete Information,” Economic Theory, Vol. 8 (1996), pp. 291-305.
• Michael R. Baye, Keith Crocker, and Jiangdong Ju, "Divisionalization, Franchising, and Divestiture Incentives in Oligopoly,” American Economic Review, Vol. 86 (March 1996), pp. 223-236.

Abstract A two-stage game is used to model firms'' strategic incentives to divide production among autonomous competing units through divisionalization, franchising, or divestiture. Firms simultaneously choose their number of competing units, which then engage in Cournot competition. While it is costly to form autonomous units, each firm does so in equilibrium, thus reducing firm profits and increasing social welfare relative to the case where firms cannot form competing units. With linear demand and costs, duopolists choose the socially optimal number of competing units; oligopolies with larger numbers of firms choose too many. The case of nonlinear demand is also examined. Copyright 1996 by American Economic Association.

• Michael R. Baye and Dan Kovenock (1994), “How to Sell a Pickup Truck:  Beat-or-Pay Advertisements as Facilitating Devices,” International Journal of Industrial Organization, Vol. 12, No. 1, pp. 21-33.
• Michael R. Baye, Guoqiang Tian, and Jianxin Zhou, “Characterizations of the Existence of Equilibria in Games with Discontinuous and Nonquasiconcave Payoffs,” Review of Economic Studies, Vol. 60 (October 1993), pp. 935-948.

Abstract This paper characterizes pure-strategy and dominant-strategy Nash equilibrium in noncooperative games that may have discontinuous and/or non-quasi-concave payoffs. Conditions called diagonal transfer quasi-concavity and uniform transfer quasi-concavity are shown to be necessary and, with conditions called diagonal transfer continuity and transfer upper semicontinuity, sufficient for the existence of pure-strategy and dominant-strategy Nash equilibrium, respectively. The results are used to examine the existence or nonexistence of equilibrium in some well-known economic games with discontinuous and/or non-quasi-concave payoffs. Copyright 1993 by The Review of Economic Studies Limited.

• Michael R. Baye, Dan Kovenock, and Casper G. de Vries, “Rigging the Lobbying Process:  An Application of the All-Pay Auction,” American Economic Review, Vol. 86 (March 1993), pp. 289-294.
• Michael R. Baye, Dan Kovenock, and Casper G. de Vries, “It Takes Two-to-Tango:  Equilibria in a Model of Sales,” Games and Economic Behavior, Vol. 4 (1992), pp. 493-510.
• Bernard van Praag and Michael R. Baye, “The Poverty Concept when Prices are Income-Dependent,” Journal of Econometrics, Vol. 43 (1990), pp. 153-166.
• Paul M. Anglin and Michael R. Baye, “Information, Multiprice Search, and Cost-of-Living Index Theory,” Journal of Political Economy, Vol. 95 (December 1987), pp. 1179-1195.

Abstract This paper derives the cost-of-living index of an individual who faces imperfect and costly information about prices. Traditional cost-of-living indexes assume that the consumer passively accepts prices as given. The authors derive a multiprice search model in which the consumer chooses the search strategy that minimizes the expected cost of buying a given level of utility. In contrast to existing search models, the mod el allows the consumer to change the allocation of expenditures among goods as information about prices changes and enables them to construct a cost-of-living index for an agent who searches across distributions of offer prices. Unlike traditional cost-of-living measures that ignore search behavior, the searcher''s cost-of-living index depends on search costs. Copyright 1987 by University of Chicago Press.

• Michael R. Baye, “A Note on Price Stability and Consumers'' Welfare,” Econometrica, Vol. 53 (January 1985), pp. 213-217.
• Michael R. Baye. “Price Dispersion and Functional Price Indices,” Econometrica, Vol. 53 (January 1985), pp. 217-223.

Abstract Recently, several Konüs cost-of-living indexes that allow stochastic prices have been described. However, under some conditions these indexes may violate an identity axiom and allow utility to increase with the measured cost of living. As an alternative I use literature on consumer surplus to describe a new Konüs index that does not violate the identity axiom and ranks price regimes in the opposite order as indirect utility functions. In addition, it provides a natural way to introduce risk aversion into cost-of-living indexes. This is demonstrated by examining the implication ofrisk aversion on the cost-of-living from fixed sample size searches.