Two is not too many for monopoly

Many research contributions have investigated the identity of the leader in oligopolistic markets. As a general rule, this literature points to the leader being either the most efficient, the largest or the best informed player. However, there tend to be exceptions to this rule and it is unclear who will become the leader when firms at the same time are different in size, efficiency of production and/or the quality of the information they have. The present paper reveals insights regarding this last question. As such, it points to the elements that really matter to explain for leadership when firms are different from each other in more than one respect. It turns out that the most efficient firm becomes the leader, regardless whether or not its rival has invested in more capacity. While this result tends to be in line with the previous findings regarding the identity of the leader being the relatively more efficient firm, it contradicts the dominant firm scenario regarding price leadership. This is the result of enlarging the strategy space of the players, by including a buyout option. As such, the paper provides the foundations and hence a theoretical justification for price leadership out of a collusive motive. Since a priori the model also does not exclude a barometric price leadership outcome, it is appropriate to conclude that the buyout option truly is a collusive device strong enough to suppress other reasons for price leadership. Therefore, the arrangements observed in reality aiming at the implementation of buyout possibilities have to be watched very closely from an antitrust perspective.     

Endogenous uncertainty in a general equilibrium model with price contingent contracts

Summary This paper views uncertainty and economic fluctuations as being primarily endogenous and internally propagated phenomena. The most important Endogenous Uncertainty examined in this paper is price uncertainty which arises when agents do not have structural knowledge and are complelled to make decisions on the basis of their beliefs. We assume that agents adopt Rational Beliefs as in Kurz [1994a]. The trading of endogenous uncertainty is accomplished by using Price Contingent Contracts (PCC) rather than the Arrow-Debreu state contingent contracts. The paper provides a full construction of the price state space which requires the expansion of the exogenous state space to include the state of beliefs. This construction is central to the analysis of equilibrium with endogenous uncertainty and the paper provides an existence theorem for a Rational Belief Equilibrium with PCC. It shows how the PCC completes the markets for trading endogenous uncertainty and lead to an allocation which is Pareto optimal. This paper also demonstrates that endogenous uncertainty is generically present in this new equilibrium.This research was supported in part by the Fondazione Eni Enrico Mattei of Milan, Italy, and by the National Science Council of Taiwan. The authors thank Carsten K. Nielsen for valuable suggestions.     

Incentive compatibility and the quantity-setting competitive firm under demand uncertainty

This paper examines the tie between the popular black box neoclassical quantity-setting firm under demand uncertainty and a firm with a rudimentary but explicit employee relation organizational structure in which workers are offered fixed wages for following management directives. Surprisingly, the quantity-setting firm unambiguously mimics optimal employment relation hiring and work rules when the contract is incentive-compatible ex post. The attitude toward risk is shown to be the key determinant of whether or not the quantity-setting firm replicates the optimal employment relation contract when ex post incentive-compatibility is relaxed.     

Dilution costs,underinvestment, and utility regulation under asymmetric information

This article addresses the problem faced by a regulated natural monopolist who must raise outside funds to finance socially desirable projects. We demonstrate that fair rate of return utility price regulation will lead to underinvestment incentives in the presence of asymmetric information between the firm and the capital markets regarding the firm's assets and future costs. This problem is especially severe when financing choice is restricted to equity. Underinvestment can be either completely eliminated by adjusting the allowed rate of return above the fair rate or reduced by switching to debt finance.Support from the Center for the Study of Regulated Industry at Georgia State University is gratefully acknowledged. We have benefited from the comments of Victor Andrews, two anonymous reviewers, and the editor, Michael A. Crew. The usual disclaimer applies.     

Optimal learning with costly adjustment

Summary We formulate an infinite-horizon Bayesian learning model in which the planner faces a cost from switching actions that does not approach zero as the size of the change vanishes. We recast the model as a dynamic programming problem which will always have a continuous value function and an optimal policy. We show that the planner's beliefs will converge eventually to some stochastic limit belief which, however, is not necessarily a point mass on the truth. The planner's actions will also converge, although not necessarily to an optimal action given the truth. A key implication of adjustment costs is that the planner will change her action only finitely many times. We present a simple example illustrating how adjustment costs can lead the planner to settle in the long run on an action that is far away from the optimal action given the truth and which yields a reward significantly below that of the optimal action.We would like to thank seminar and conference participants at Brown University, the Social Science Research Council Workshop on Soviet and East European Economics in Pittsburgh, the Econometric Society in Philadelphia, and the Society for Economic Dynamics and Control in Montreal. The bulk of this work was done while Mark Feldman was at the University of Illinois, Champaign-Urbana.     

Technological paradigms,patterns of learning and development: An introductory roadmap

This paper presents an evolutionary microeconomic theory of innovation and production and discusses its implications for development theory. Using the notions of technological paradigm and trajectory, it develops an alternative view of firm behavior and learning. It is shown then how these are embedded in broader national systems of innovation which account for persistent differences in technological cappacities between countries. Finally, this bottom-up evolutionary analysis is linked with an institutional top-down approach, and the potential fruitfulness of this dialogue is demonstrated.We thank the discussants and participants at the workshop on Technology and Competitiveness in Developing Countries, Venice, 26/11/93, for their useful comments.The research leading to this work has benefited at various stages from the support of the Italian National Research Council (CNR, Progetto Strategico Combiamento Technologico e Crescita Economica) and of the International Institute of Applied System Analysis (IIASA, Austria).     

Ein Entscheidungsmodell für Konsumieren und Sparen

Summary The present study analyses the simultaneous problem of consumption and saving by means of a consistent demand system; for this purpose the linear—expenditure—system (LES), developed by R. Stone, has been modified and used as a methodological base. Saving takes, for the sake of operationality, the character of a consumer—good and becomes an argument of the utility function. The usual neoclassical assumption of utility maximization allows the derivation of a linear expenditure system of consumption and saving (LESSC) when prices and income are given. The simultaneous LESSC-model has remarkable weaknesses, however: the assumption of certainty, the static character of the model, the disregard for major savings—motives and private expenditure on homebuiding led to bad elasticity—estimates. The assumpion of directly—additive utility functions causes furthermore collinearity between income—and price—elasticities such that the meaning of the derived elasticities is greatly reduced.The income—elasticities derived from the LESSC are positive throughout but show a remarkable variance. The calculation of the Friedman—bias demonstrates a rather strong bias due to the assumption of certainty. A modification resulted in income—elasticities of private consumption and savings of around 0,93 (unmodified: 0,88) and 1,41 (unmodified: 1,76). The demand for consumption goods of great necessity was income—inelastic whereas the demand for goods of less importance to survival was income—elastic. An analysis of income—elasticities of the disaggregated system and the relation between transitory components of consumption and income existing in Austria gave the impression that unexpected changes in income are not only reflected in saving but also in changes of the consumption—structure.The respective price—elasticites are all negative and smaller than 1. For less important consumption—goods lower price—elasticities have been measured and for easily substitutable goods higher ones. Marked crossprice—elasticities could only by discovered with clothing and food products. Generally it can be said that an increase in prices of goods of the daily needs hits both the expenditure on easily substitutable consumption goods and causes dissaving.A comparison with the elasticities calculated through OLS shows a greater reliance of LESSC—elasticities as far as data of differing aggregation levels are concerned.

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Mécanique Sociale may one day take her place along with Mécanique Celeste throned each upon the double—sided height of one maximum principle, the supreme pinnacle of moral as of physical science.     

The Incremental Surplus Subsidy and rate-of-return regulation

Sappington and Sibley (1988) propose an alternative regulatory mechanism, the Incremental Surplus Subsidy (ISS), that would induce the regulated firm to set price at marginal cost and eliminate all waste. The ISS would give the firm a subsidy equal to the one-period gain in consumer surplus resulting from its pricing decision. This article shows that the ISS does not induce greater production efficiency than traditional rate-of-return (ROR) regulation. The author proposes a super-ISS mechanism that would give the firm a subsidy greater than the gain in consumer surplus resulting from its pricing decisions. This super-ISS mechanism is shown to result in greater benefits than either ISS or ROR regulation.     

Communication in dynastic repeated games: ‘Whitewashes’ and ‘coverups’

Summary. We ask whether communication can directly substitute for memory in dynastic repeated games in which short lived individuals care about the utility of their offspring who replace them in an infinitely repeated game. Each individual is unable to observe what happens before his entry in the game. Past information is therefore conveyed from one cohort to the next by means of communication.When communication is costless and messages are sent simultaneously, communication mechanisms or protocols exist that sustain the same set of equilibrium payoffs as in the standard repeated game. When communication is costless but sequential, the incentives to whitewash the unobservable past history of play become pervasive. These incentives to whitewash can only be countered if some player serves as a neutral historian who verifies the truthfulness of others reports while remaining indifferent in the process. By contrast, when communication is sequential and (lexicographically) costly, all protocols admit only equilibria that sustain stage Nash equilibrium payoffs.We also analyze a centralized communication protocol in which history leaves a footprint that can only hidden by the current cohort by a unanimous coverup. We show that in this case the set of payoffs that are sustainable in equilibrium coincides with the weakly renegotiation proof payoffs of the standard repeated game.Received: 30 September 2002, Revised: 5 August 2003, JEL Classification Numbers: C72, C73, D82.We wish to thank an Associate Editor and Dino Gerardi as well as seminar participants at Arizona State, Columbia, Duke, Georgetown, Indiana, Montreal, Princeton, Rochester, Vanderbilt, VPI, the 2001 NSF/NBER Decentralization Conference, the Summer 2001 North American Econometric Society Meetings, and the Midwest Theory Conference, 2000, for useful comments and suggestions. All errors are our own.     

Mutually Destructive Bidding: The FCC Auction Design Problem

In general, synergies across license valuations complicate the auction design process. Theory suggests that a simple (i.e., non-combinatorial) auction will have difficulty in assigning licenses efficiently in such an environment. This difficulty increases with increases in fitting complexity. In some environments, bidding may become mutually destructive. Experiments indicate that a properly designed combinatorial auction is superior to a simple auction in terms of economic efficiency and revenue generation in bidding environments with a low amount of fitting complexity. Concerns that a combinatorial auction will cause a threshold problem are not borne out when bidders for small packages can communicate.     

Endogenous Entry and Exit in Common Value Auctions

We develop and experimentally test a model of endogenous entry, exit, and bidding in common value auctions. The model and experimental design include an alternative profitable activity (a safe haven) that provides agentspecific opportunity costs of bidding in the auction. Each agent chooses whether to accept the safe haven income or forgo it in order to bid in the auction. Agents that enter the auction receive independently-drawn private signals that provide unbiased estimates of the common value. The auctioned item is allocated to the high bidder at a price that is equal to the high bid. Thus the market is a first-price sealed-bid common value auction with endogenous determination of market size.     

The greenhouse effect: Damages,costs and abatement

The buildup of so-called greenhouse gases in the atmosphere — CO₂ in particular-appears to be having an adverse impact on the global climate. This paper briefly reviews current expectations with regard to physical and biological effects, their potential costs to society, and likely costs of abatement. For a worst case scenario it is impossible to assess, in economic terms, the full range of possible non-linear synergistic effects. In the most favorable (although not necessarily likely) case (of slow-paced climate change), however, it seems likely that the impacts are within the affordable range, at least in the industrialized countries of the world. In the third world the notion of affordability is of doubtful relevance, making the problem of quantitative evaluation almost impossible. We tentatively assess the lower limit of quantifiable climate-induced damages at $30 to $35 per ton of CO₂ equivalent, worldwide, with the major damages being concentrated in regions most adversely affected by sea-level rise. The non-quantifiable environmental damages are also significant and should by no means be disregarded.The costs and benefits of (1) reducing CFC use and (2) reducing fossil fuel consumption, as a means of abatement, are considered in some detail. This strategy has remarkably high indirect benefits in terms of reduced air pollution damage and even direct cost savings to consumers. The indirect benefits of reduced air pollution and its associated health and environmental effects from fossil-fuel combustion in the industrialized countries range from $20 to $60 per ton of CO₂ eliminated. In addition, there is good evidence that modest (e.g. 25%) reductions in CO₂ emissions may be achievable by the U.S. (and, by implication, for other countries) by a combination of increased energy efficiency and restructuring that would permit simultaneous direct economic benefits (savings) to energy consumers of the order of $50 per ton of CO₂ saved. A higher level of overall emissions reduction — possibly approaching 50% — could probably be achieved, at little or not net cost, by taking advantage of these savings.We suggest the use of taxes on fossil fuel extraction (or a carbon tax) as a reasonable way of inducing the structural changes that would be required to achieve significant reduction in energy use and CO₂ emissions. To minimize the economic burden (and create a political constituency in support of the approach) we suggest the substitution of resource-based taxes in general for other types of taxes (on labor, income, real estate, or trade) that are now the main sources of government revenue. While it is conceded that it would be difficult to calculate the optimal tax on extractive resources, we do not think this is a necessary prerequisite to policy-making. In fact, we note that the existing tax system has never been optimized according to theoretical principles, and is far from optimal by any reasonable criteria.During the academic year 1989–90 Dr. Ayres was at the International Institute for Applied Systems Analysis (IIASA), Laxenburg, Austria.During the summer of 1989 Mr. Walter was a member of the Young Scientists' Summer Program at IIASA.     

Rent extraction and incentives for efficiency in recent regulatory proposals

Building on a simple model proposed by Schmalensee (1989), this paper uses simulation techniques to analyze and compare various regulatory schemes including Schmalensee's family of (linear) good regulatory regimes, a price-cap regime allowing for downward price flexibility, and a regime that combines price-cap and profit sharing. The quantitative analysis pays particular attention to measuring the trade-off between rent extraction and incentives for efficiency. The main findings of this study can be summarized as follows. First, it appears that pure price-cap regulation leaves substantial rent to the firm relative to the other regimes. Second, introducing room for downward price flexibility improves efficiency of price-cap over Schmalensee's linear regulatory regimes. Finally, by correcting in part for the distributional distortion of price-cap, the profit-sharing mechanism often yields levels of welfare comparable to optimal regulation levels.     

Perfect Bayesian implementation

Summary We study Social Choice Sets (SCS) implementable as perfect Bayesian equilibria of some incomplete information extensive form game. We provide a necessary condition which we callcondition . The condition is analogous tocondition C that Moore and Repullo [1988] show to be necessary for subgame perfect implementation in games of complete information, and it is weaker than the Bayesian Monotonicity condition stated in Jackson [1991]. Our first theorem establishes that Incentive Compatibility, Closure and Condition are necessary for implementation.Our second theorem establishes sufficient conditions. We show that any SCS which satisfies Incentive Compatibility, Closure and a condition called Sequential Monotonicity No Veto (SMNV) is implementable. SMNV is similar in spirit but weaker than the Monotonicity No Veto condition stated in Jackson [1991]. It is also similar to a combination of condition and No Veto Power, which Abreau and Sen show to be sufficient for implementation in subgame perfect equilibrium.This paper is a revised version of a chapter of my dissertation at Stanford University, Graduate School of Business. I would like to thank, without implicating, Faruk Gul, Bob Wilson and especially John Roberts for their constant advice and encouragement. I would also like to thank participants at the 1993 Summer Meeting of the Econometric Society and a referee for comments leading to substantial improvement in the paper. Financial support from Bocconi University is gratefully acknowledged.     

Convention, Social Order, and the Two Coordinations

The word coordination has two meanings, and thesemeanings are often conflated. One meaning, associated with ThomasSchelling, is seen in situations like choosing whether to driveon the left or the right; the drivers must coordinate to eachother's behavior. The other meaning, associated with FriedrichHayek, means that a concatenation of activities is arranged soas to produce good results. Along with the Schelling sense ofcoordination comes the notion of convention, such as drivingon the right. Some conventions are consciously designed; othersemerge without design (or are emergent). Along with the Hayeksense of coordination comes the notion of social order. Somesocial orders, such as the skeleton of activities within thefirm or within the hypothetical socialist economy, are consciouslyplanned. Other social orders, such as the catallaxy of the freesociety, function without central planning (or are spontaneous).Distinguishing between the two coordinations (and, in parallelfashion, between convention and social order) clarifies thinkingand resolves some confusions that have arisen in discussionsof coordination and spontaneous order. The key distinctionsare discussed in the context of the thought of, on the one hand,Menger, Schelling, David Lewis, and the recent path-dependencetheorists, and, on the other hand, Smith, Hayek, Polanyi, Coase,and the modern Austrian economists. The paper concludes witha typology that encompasses the several distinctions.     

Exchange rates and perfect competition

The purpose of this note is to demonstrate that the commonly held belief that incomplete and perverse pass-through are incompatible with perfect competition is wrong! To this end, we consider two types of firms both operating in two countries. The demand sides of the markets of the two countries are separated and each type of firm produces its good in one of these countries. We study the effect of an exchange-rate change on the competitive equilibrium prices in each country. When producing for the foreign market causes the same costs as producing for the home market then the law of one price holds and an exchange-rate change is completely offset by price changes. Furthermore, when cost functions neither exhibit economies nor diseconomies of scope between producing for the home and producing for the foreign market then prices move in the right directions in response to an exchange-rate change. However, with general cost structures, even in this simple perfectly competitive model, perverse directions of price changes can result from an exchange-rate change.     

Power,luck and the right index

Summary We have pointed out the theoretical drawbacks of the traditional indices for measuring a priori voting power inasmuch as they are implied in considering the coalition value a private good. This criticism caused us to view the coalition outcome as a public good. From this aspect and additional considerations with respect to power, luck, and decisiveness, we obtained a story describing the characteristics of an adequate measure of a priori voting power. These characteristics were found to be fulfilled by an index presented by Holler (1978). Through the above analysis this index has received its theoretical justification. An independent view of this index was then provided by means of an axiomatic characterization. This characterization makes possible abstract comparison of the index with previously established private good indices.While we have restricted our attention to simple games, the index presented can be generalized to provide a value on games in characteristic function form. We leave this topic for future conideration.     

Stable cartels revisited

Summary. This paper analyzes cartel stability when firms are farsighted. It studies a price leadership model á la D Aspremont et al. (1983), where the dominant cartel acts as a leader by determining the market price, while the fringe behaves competitively. According to D Aspremont et al. s (1983) approach a cartel is stable if no firm has an incentive to either enter or exit the cartel. In deciding whether to deviate or not, a firm compares its status quo with the outcome its unilateral deviation induces. However, the firm fails to examine whether the induced outcome will indeed become the new status quo that will determine its profits. Although the firm anticipates the price adjustment following its deviation, it ignores the possibility that more firms may exit (or enter) the cartel. In other words, the firm does not consider the fact that the outcome immediately induced by its deviation may not be stable itself. We propose a notion of cartel stability that allows firms to fully foresee the result of their deviation. Our solution concept is built in the spirit of von Neumann and Morgensterns (1944) stable set, while it modifies the dominance relation following Harsanyis (1974) criticism. We show that there always exists a unique, non-empty set of stable cartels.Received: 20 August 2002, Revised: 11 August 2004, JEL Classification Numbers: C79, D43, D49, L13.On page 921, the final paragraph as well as the two references by Rothschild were inserted.This revised version was pulished in February 2005.I would like to thank Joseph Greenberg, Licun Xue, Daniel Arce M. and Curtis Eberwein for their helpful suggestions on an earlier draft. I am indebted to an anonymous referee for his very constructive comments.     

Zur Frage der Wirtschaftsmacht

Ohne ZusammenfassungNach einem in der Nationalökonomischen Gesellschaft in Wien am 27. April 1954 gehaltenen Vortrag.     

Spieltheorie: Ein neues Paradigma der Sozialwissenschaft

Ohne ZusammenfassungDeutsche Fassung des Artikels Game Theory: A New Paradigm of Social Science, erschienen in New Methods of Thought and Procedure (Berlin-Heidelberg-New York: Springer, 1967). — Diese Arbeit wurde teilweise über das Econometric Research Program der Princeton University durch das Office of Naval Research unterstützt.