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

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.