Dynamic Stability, Paradoxical Comparative Statics, and Factor–Market Distortions in an Economy with Three Production Sectors

In an earlier paper the authors clarified the relationship between the stability of long–run equilibrium and the possibility of paradoxical comparative statics in the Lerner–Samuelson two–by–two model of production with factor–market distortions (see Review of International Economics 9 (1901) :383–400). The present paper extends the analysis to an economy with three production sectors. It is found that almost all properties of long–run equilibrium in the two–by–two model with factor–market distortions continue to hold, while some new properties, such as plurality of equilibrium, appear. Specifically, the instability of the adjustment process is not ruled out; a paradox cannot coexist with stable equilibrium in a small open economy, but may do so in a closed economy.     

Imperfect competition and capital accumulation: the role of price normalization

We consider a capital-accumulation model with infinitely lived households and two production sectors. The intermediate-good sector is characterized by perfect competition, a constant-returns-to-scale technology, and production externalities. The final-good sector is a monopoly operating under constant returns to scale. We analyze the general equilibrium in the sense of Gabszewicz and Vial [Journal of Economic Theory (1972) 4: 381–400] for this economy and different price-normalization rules. It is shown that the qualitative behavior of the equilibrium paths depends crucially on the chosen normalization rule. In particular, whether equilibria are monotonic or oscillating and whether indeterminacy occurs or not may depend on the choice of the numeraire.     

Income Taxes,Subsidies to Education,and Investments in Human Capital

We study a two‐sector economy with investments in human and physical capital and imperfect labor markets. Investments are irreversible and noncontractible, due to random matching between firms and workers. Income is allocated according to the Nash bargaining mechanism. At equilibrium, given the distribution of the agents across sectors, there is underinvestment in both human and physical capital, due to the holdup problem generated by bargaining and noncontractibility. Self‐selection of the agents into the two sectors typically induces too many workers to invest in high skills. Compared to the constrained efficient allocation, at each equilibrium, there are too many people investing too little effort in the high‐skill sector. We also study the effects of several tax policies on total expected surplus.     

Contracts and externalities: How things fall apart

A single principal interacts with several agents, offering them contracts. The crucial assumption of this paper is that the outside-option payoffs of the agents depend positively on how many uncontracted or “free” agents there are. We study how such a principal, unwelcome though he may be, approaches the problem of contract provision to agents when coordination failure among the latter group is explicitly ruled out. Two variants are considered. When the principal cannot re-approach agents, there is a unique equilibrium, in which contract provision is split up into two phases. In phase 1, simultaneous offers at good (though varying) terms are made to a number of agents. In phase 2, offers must be made sequentially, and their values are “discontinuously” lower: they are close to the very lowest of all the outside options. When the principal can repeatedly approach the same agent, there is a multiplicity of equilibria. In some of these, the agents have the power to force delay. They can hold off the principal's overtures temporarily, but they must succumb in finite time. In both models, despite being able to coordinate their actions, agents cannot resist an “invasion” by the principal and hold to their best payoff. It is in this sense that “things [eventually] fall apart”.     

Fashion statement

We study bilateral matching under private information about agents' characteristics. Assortative matching is the only equilibrium outcome in the absence of private information. When an information friction is present, the matching process can be improved if a payoff-irrelevant variable which we term “fashion” is introduced. Informed agents choose to adopt fashion as a signaling device. If success in matching is observed, other agents can imitate the signal. Thus, for fashion to be useful, it must constantly change. If there are more than two types of agents, both “high” and “low” fashion are needed to facilitate assortative matching.     

Perpetual youth and endogenous labor supply: A problem and a possible solution

In the “perpetual youth” overlapping-generations model of Blanchard and Yaari, if leisure is a “normal” good then some agents will have negative labor supply. We suggest a solution to this problem by using a modified version of Greenwood, Hercowitz and Huffman’s utility function. The modification incorporates real money balances, so that the model may be used to analyze monetary as well as fiscal policy. In a Walrasian version of the economy, we show that increased government debt and increased government spending raise the interest rate and lower output, while an open-market operation to increase the money supply lowers the interest rate and raises output.     

International tax arbitrage, tax evasion and interest parity conditions

Using a finite-horizon general equilibrium model with uncertainty and money, we characterize situations where tax arbitrage opportunities may arise for international portfolio investors in an economy with heterogeneous capital income taxation when there is some scope to evade taxes on foreign capital income. We derive tax-modified uncovered interest parity conditions and forward rates similar to the no-tax ones, but augmented by tax-induced “risk-premium” terms; covered interest parity conditions remain unaffected by the introduction of capital income taxes, a consequence of our approach of bounding tax-based arbitrage without restricting arbitrage per se.     

Knowledge, economic structure, and growth

This paper proposes a two-sector growth model to examine the dynamic interactional relationships between capital and knowledge. The economy consists of two production sectors—industry and service—and one knowledge production sector—research institutions and universities. The university is financially supported by the government by taxing the service and industrial sectors. We provide a compact framework for analyzing the interactions of the three sectors with a given population and a fixed preference structure of the population. The model also determines the dynamics of the price of the industrial good, the wage rate, and the interest rate. First, we guarantee the existence of equilibria and provide the stability conditions. Then, we examine the effects of changes in the government's research policy and some other parameters upon the system.     

The creative class, its preferences, and unbalanced growth in an urban economy

We theoretically analyze unbalanced growth in an urban economy arising from the preferences of the creative class concerning the relative desirability of agricultural, manufacturing, and service goods. We study two cases. In the first case, the production functions for the three categories of goods are identical. Our analysis leads to four results. First, we compute the equilibrium physical to creative capital ratios and the relationships between the neutral productivity shifters and the output prices. Second, we show that agricultural and services consumption are a constant multiple of manufacturing consumption. Third, we note that under certain conditions, an equilibrium in which all sectors of our urban economy grow at a constant rate does not exist. Fourth, we show that a constant growth path (CGP) equilibrium exists in which, across the three sectors, the pattern of consumption changes and there is a reallocation of creative capital. In the second case, the production functions for the three categories of goods are dissimilar. In this more realistic setting, we study generalizations of the previously described four results.     

Don’t let your robots grow up to be traders: Artificial intelligence, human intelligence, and asset-market bubbles

Researchers who have examined markets populated by “robot traders” have claimed that the high level of allocative efficiency observed in experimental markets is driven largely by the “intelligence” implicit in the rules of the market. Furthermore, they view the ability of agents (artificial or human) to process information and make rational decisions as unnecessary for the efficient operation of markets. This paper presents a new series of market experiments that show that markets populated with standard robot traders are no longer efficient if time is a meaningful element, as it is in all asset markets. While simple two-season markets with human subjects reliably converge to an efficient equilibrium, markets with minimally intelligent robot traders fail to attain this equilibrium. Instead, these markets overshoot the equilibrium and then crash below it. In addition to firmly establishing the role of trader intelligence in asset-market equilibrium, these experiments also provide insights into why bubbles and crashes are consistently observed in many asset-market laboratory experiments using human subjects.     

Achieving efficiency with manipulative bargainers

Two agents bargain over the allocation of a bundle of divisible commodities. After strategically reporting utility functions to a neutral arbitrator, the outcome is decided by using a bargaining solution concept chosen from a family that includes the Nash and the Raiffa–Kalai–Smorodinsky solutions. When reports are restricted to be continuous, strictly increasing and concave, it has been shown that this kind of “distortion game” leads to inefficient outcomes. We study the distortion game originated when agents are also allowed to claim non-concave utility functions. Contrasting with the previous literature, any interior equilibrium outcome is efficient and any efficient allocation can be supported as an equilibrium outcome of the distortion game. In a similar fashion to the Nash demand game we consider some uncertainty about the opponent's features to virtually implement the Nash bargaining solution.     

Ethanol Production, Food and Forests

This paper investigates the direct and indirect impacts of ethanol production on land use, deforestation and food production. A partial equilibrium model of a national economy with two sectors and two regions, one of which includes a forest, is developed. It analyses how an exogenous increase in the ethanol price affects input allocation (land and labor) between sectors (energy crop and food). The total effect of ethanol prices on food production and deforestation is decomposed into three partial effects. First, the well-documented effect of direct land competition between rival uses arises; it increases deforestation and decreases food production. Second, an indirect displacement of food production across regions, possibly provoked by the reaction of international food prices, increases deforestation and reduces the food sector’s output. Finally, labor mobility between sectors and regions tends to decrease food production but also deforestation. The total impact of ethanol production on food production is negative while there is an ambiguous impact on deforestation.     

Temporal convergence and factor intensities

In the two-sector neoclassical production model with no factor-market distortions, the value and physical factor-intensity rankings of the two sectors may differ when the economy is out of long-run equilibrium, but such a difference does not imply any failure of convergence to long-run equilibrium.     

Equilibria in systems of social interactions

In this paper, we establish existence and uniqueness results for equilibria in systems with an infinite number of agents and with local and global social interactions. We also examine the structure of the equilibrium distribution and derive a “Markov”property for the equilibrium distribution of a class of spatially homogeneous systems.     

“Very Nice” trivial equilibria in strategic market games

Following Shapley [Theory of Measurement of Economic Externalities, Academic Press, New York, 1976], we study the problem of the existence of a Nash Equilibrium (NE) in which each trading post is either active or “legitimately” inactive, and we call it a Shapley NE. We consider an example of an exchange economy, borrowed from Cordella and Gabszewicz [Games Econ. Behav. 22 (1998) 162–169], which satisfies the assumptions of Dubey and Shubik [J. Econ. Theory 17 (1978) 1–20], and we show that the trivial equilibrium, the unique NE of the associated strategic market game, is not “very nice,” in the sense that it is not “legitimately” trivial. This result has the more general implication that, under the Dubey and Shubik's assumptions, a Shapley NE may fail to exist.     

Modelling price pressure in financial markets

We present experimental evidence that, unlike traditional assumptions in economic theory, security prices do not respond to pressure from their own excess demand. Instead, prices respond to excess demand of all securities, despite the absence of a direct link between markets. We propose a model of price pressure that explains these findings. In our model, agents set order prices that reflect the marginal valuation of desired future holdings, called “aspiration levels.”In the short run, as agents encounter difficulties executing their orders, they scale back their aspiration levels. Marginal valuations, order prices, and hence, transaction prices change correspondingly. The resulting price adjustment process coincides with the Global Newton Method. The assumptions of the model as well as its empirical implications are fully borne out by the data. Our model thus provides an economic foundation for why markets appear to search for equilibrium according to Newton’s procedure.     

A Note on Multi-Issue Two-Sided Bargaining: Bilateral Procedures

This note considers a two-sided multi-issue bargaining problem in which players that belong to the same “side” may have conflicting priorities regarding the different negotiated issues. The note examines different bilateral bargaining procedures and shows the different equilibrium settlements that they yield. In particular the note examines the possibility that group heterogeneity (conflicting priorities) may be exploited in order to gain a better settlement. The different potential outcomes that are implied by the different procedures explain why we often observe such intense negotiation over bargaining procedures. Moreover, the conflict over procedure can be substantial, among parties with common interest as well as between opposing players. Journal of Economic Literature Classification Number: C7.     

Power, Distributive Conflicts, and Multiple Growth Paths

This article shows that multiple growth paths may occurin a politico-economic model of endogenous growth. This multiplicityis characterized by the coexistence of the low-tax, low-capital-flightequilibrium and a high-tax, high-capital-flight equilibrium.The likelihood of multiplicity is crucially related to the structureof power in society—namely, it is necessary that the politicallydecisive agents have a greater access to international capitalmarkets than the average in the economy.     

Growth,economic structure,and residential distribution of a small city

This article presents a growth model of a small open city with economic structure and geography. The city which is located along a line segment has three, industrial, services and housing, sectors. The spatial growth model of a small city synthesizes the main ideas in some important models in the neoclassical growth theory, urban economics, and the literature of economic growth of small open economies. We show that the dynamic system has a unique equilibrium. We also simulate the motion of the urban economy over time and space. The unique feature of our approach is to treat production activities, economic structure, residential distribution, capital accumulation, and consumption on the basis of microeconomic mechanism as an integrated whole. Our simulation provides some important insights into the processes of the urban economic growth. For instance, under certain conditions, when the industrial sector’s productivity is increased, the wage rate, price of services, capital intensities of the services and industrial sectors, and per-worker output levels of the two sectors are increased. The total labor supply, the capital stocks employed by the three sectors and the labor forces by the service and industrial sectors are all increased. The shares of the three sectors are not affected by the technological change in the long term, even though the shares are initially affected. The per capita consumption level of the industrial goods rises and the consumption level of services falls. The land and housing rents are increased and the consumption of housing per household falls. Moreover, the current account balance tends to be more in surplus and the growth rate is increased.     

Factor Endowments,Democracy, and Trade Policy Divergence

We develop a stochastic model of electoral competition in order to study the economic and political determinants of trade policy. We model a small open economy with two tradable goods, each of which is produced using a sector‐specific factor (e.g., land and capital) and another factor that is mobile between these tradable sectors (labor); one nontradable good, which is also produced using a specific factor (skilled labor), and an elected government with the mandate to tax trade flows. The tax revenue is used to provide local public goods that increase the economic agents’ utility. We use this general equilibrium model to explicitly derive the ideal policies of the different socioeconomic groups in society (landlords, industrialists, labor, and skilled workers). We then use those ideal policies to model the individual probabilistic voting behavior of the members of each of these socioeconomic groups. We use this model to shed light on how differences in the comparative advantages of countries explain trade policy divergence between countries as well as trade policy instability within countries. We regard trade policy instability to mean that, in equilibrium, political parties diverge in terms of the political platforms they adopt. We show that in natural resource (land)–abundant economies with very little capital, or in economies that specializes in the production of manufactures, parties tend to converge to the same policy platform, and trade policy is likely to be stable and relatively close to free trade. In contrast, in a natural resource–abundant economy with an important domestic industry that competes with the imports, parties tend to diverge, and trade policy is likely to be more protectionist and unstable.