Giffen goods and market making

Summary. This paper shows that information effects per se are not responsible for the Giffen goods anomaly affecting traders demands in multi asset noisy, rational expectations equilibrium markets. The role that information plays in traders strategies also matters. In a market with risk averse, uninformed traders, informed agents have a dual trading motive: speculation and market making. The former entails using prices to assess the effect of error terms; the latter requires employing them to disentangle noise traders demands within aggregate orders. In a correlated environment this complicates the signal extraction problem and may generate upward sloping demand curves. Assuming (i) that competitive, risk neutral market makers price the assets or that (ii) uninformed traders risk tolerance coefficient grows unboundedly, removes the market making component from informed traders demands rendering them well behaved in prices.Received: 30 April 2002, Revised: 3 December 2003, JEL Classification Numbers: G100, G120, G140.Support from the Barcelona Economics Program of CREA and the Ente per gli Studi Monetari e Finanziari Luigi Einaudi, are gratefully acknowledged. I thank Anat Admati, Jordi Caballé, Giacinta Cestone, and Xavier Vives for useful suggestions. The comments provided by the Associate Editor and an anonymous referee greatly improved the papers exposition.     

The equilibrium manifold keeps the memory of individual demand functions

Summary. It is shown that the property that the equilibrium manifold keeps the memory of the individual demand functions holds true if every individual demand function satisfies the following three properties: 1) It is a function of commodity prices and of consumers income; 2) Consumption belongs to the nonnegative orthant of the commodity space; 3) Walras law. Neither differentiability nor continuity are necessary. In addition, the demand functions do not have to be utility maximizing subject to budget constraints.Received: 2 September 2003, Revised: 26 January 2004, JEL Classification Numbers: D50, D51.A preliminary version of this paper was released in October 1999 under the title Deriving individual demand functions from the equilibrium manifold. I wish to thank an anonymous referee for thoughtful comments.     

Price-Cost Margins and Profit Rates in New Zealand Electricity Distribution Networks Since 1994: the Cost of Light Handed Regulation

From 1994 to 2003, New Zealands corporatized electricity lines networks operated with no industry regulator, but under the spotlight of mandatory information disclosure. As a result there exists a large body of detailed, audited and publicly available accounting data on the financial performance of these businesses. Using that data, this paper finds that price-cost margins have widened substantially since deregulation. We estimate the extent to which light-handed regulation has allowed profits to exceed the levels which would have been acceptable under the old rate-of-return regulatory framework, and find that the answer is about $200 million per year, on an ongoing basis.We thank colleagues at Victoria University, and two anonymous referees for this journal, for constructive comments on this paper. Any remaining errors are entirely our responsibility.JEL classification: D21; K23; L11; L43; L51     

A general equilibrium framework for the affine class of term structure models

The Duffie and Kan (1966) model, which can be considered as the most general affine term structure formulation, was originally specified in terms of risk-adjusted stochastic processes for its state variables. The goal of the present paper is to derive a Duffie and Kan (1966) model specification under the physical probability measure that is compatible with the formulation given by the authors under the equivalent martingale (money market account) measure. For that purpose, the Duffie and Kan (1966) model will be fitted into a general equilibrium monetary framework. The resulting analytical solution for the vector of factor risk premiums enables the econometric estimation of the model parameters using a time-series or a panel-data approach, and nests, as special cases, several other specifications already proposed in the literature.Received: November 2002, Accepted: February 2004, JEL Classification: E43, G11, G12Financial support by FCTs research grant PRAXISXXI/BD/5712/95 is gratefully acknowledged.     

Biological Adaptation in Human Societies: a ‘Basic Needs’ Approach

The groundzero premise (so to speak) of the biological sciences is that survival and reproduction is the basic, continuing, inescapable problem for all living organisms; life is at bottom a survival enterprise. It follows that survival is the paradigmatic problem for human societies as well; it is a prerequisite for any other, more exalted objectives. Although the term adaptation is also familiar to social scientists, until recently it has been used only selectively, and often very imprecisely. Here a more rigorous and systematic approach to the concept of adaptation is proposed in terms of basic needs. The concept of basic human needs has a venerable history – tracing back at least to Plato and Aristotle. Yet the development of a formal theory of basic needs has lagged far behind. The reason is that the concept of objective, measurable needs is inconsistent with the theoretical assumptions that have dominated economic and social theory for most of this century, namely, valuerelativism and cultural determinism. Nevertheless, there have been a number of efforts over the past 30 years to develop more universalistic criteria for basic needs, both for use in monitoring social wellbeing (social indicators) and for public policy formulation. Here I will advance a strictly biological approach to perationalizing the concept of basic needs. It is argued that much of our economic and social life (and the motivations behind our revealed preferences and subjective utility assessments), not to mention the actions of modern governments, are either directly or indirectly related to the meeting of our basic survival needs. Furthermore, these needs can be specified to a first approximation and supported empirically to varying degrees, with the obvious caveat that there are major individual and contextual variations in their application. Equally important, complex human societies generate an array of instrumental needs which, as the term implies, serve as intermediaries between our primary needs and the specific economic, cultural and political contexts within which these needs must be satisfied. An explicit framework of Survival Indicators, including a profile of Personal Fitness and an aggregate index of Population Fitness, is briefly elucidated. Finally, it is suggested that a basic needs paradigm could provide an analytical tool (a biologic) for examining more closely the relationship between our social, economic and political behaviors and institutions and their survival consequences, as well as providing a predictive tool of some value.     

Political and Regulatory Risk: Beta Sensitivity in U.K. Electricity Distribution*

To establish price caps, regulators must determine appropriate returns for utilities capital employed. This paper uses the techniques of the Kalman Filter to estimate daily betas for the U.K.s regional electricity companies in the period from privatization to end-1998. The paper demonstrates that utilities risk is time-variant, and establishes significant political and regulatory influences in the systematic risk faced by shareholders. It finds beta to be mean reverting, with little evidence of cyclical variation across the regulatory review cycle. The paper confirms the prevalence of significant excess returns in U.K. privatized electricity distribution and suggests that over-estimation of the systematic risk faced by investors may imply further excess returns in the next regulatory review period.     

Combining Keynes and Schumpeter. Ingvar Svennilson’s contribution to the Swedish growth school and modern economics

In a study of European growth in the interwar period, the Swedish economist Ingvar Svennilson integrated a Keynesian theory of demand-led cumulative growth with a Schumpeterian analysis of transformation. Today, Svennilson is seen, together with the Schumpeterian economists Johan Åkerman and Erik Dahmén, as members of a unique Swedish growth school. A combination of Keynes and Schumpeter with Svennilson as a mediator has been facilitated by neo-Schumpeterian theories of demand-led innovations. But it has been obstructed by a hypothesis in the Schumpeterian tradition that productivity growth is stimulated by low aggregate demand and by Svennilsons strong commitment to Verdoorns Law which actually is Svennilsons Law. However, Svennilsons analyses of the importance of short-run imbalances for economic growth and the existence of imperfect capital markets discriminating progressive new firms have direct equivalences in modern macroeconomics. Svennilsons main contributions to economics of today are his syntheses between macroeconomic and structural analysis, short and long run theoretical perspectives and, more basically, between theoretical and empirical research.JEL Classification: B25, E32, L6, N14, O11, O14, O31, O4A Swedish version of the paper was presented at the 7th Nordic Conference on the History of Economic Thoughts in Molde (Norway), May 2-4, 2003 and at the Ratio institute (Stockholm), May 8, 2003. I thank participants, Rolf Henriksson and two anonymous referees for valuable comments.     

The distribution of money and prices in an equilibrium with lotteries

Summary. We construct a tractable fundamental model of money with equilibrium heterogeneity in money balances and prices. We do so by considering randomized monetary trades in a standard search-theoretic model of money where agents can hold multiple units of indivisible tokens and can offer lotteries on monetary transfers. By studying a simple trading pattern, we can analytically characterize the monetary distribution. Interestingly, such distributions match those observed in numerically simulated economies with fully divisible money and price heterogeneity.Received: 16 April 2003, Revised: 11 February 2004JEL Classification Numbers: D30, D83, E40.A. Berentsen, G. Camera, C. Waller: The paper has benefitted from insightful comments of two anonymous referees, whom we thank. We also thank participants at the conference Recent Developments in Money and Finance, held at Purdue University in May 2003, and the EPRI/University of Western Ontario Money Conference held in October 2003. Correrspondence to: G. Camera     

Factor price equalization beyond a “cubic” world

Summary. The importance of factor price equalization (FPE) is widely recognized in economics. The FPE theorem states that, absent any factor intensity reversal, factor prices are equal across countries with identical technologies and product mixes. In a two-factor-two-good-two-country Heckscher-Ohlin model this is equivalent to countries factor endowments being contained in the diversification cone defined by goods factor intensities. This paper identifies a condition, stated in terms of the allocation of factor endowments across countries relative to the demand for and the factor intensities of goods, that is necessary and sufficient for FPE in a world with arbitrary number of countries, goods and factors.Received: 16 July 2004, Revised: 10 January 2005, JEL Classification Numbers: F1.     

Institutional Evolution through Purposeful Selection: The Constitutional Economics of John R. Commons

The paper relates John. R. Commons view on the roleof human design in institutional evolution to the views thathave been advanced on this matter by F. A. Hayek, in German ordo-liberalism,and in constitutional political economy. It is argued that Commonsconcept of purposeful selection points in the direction ofa theoretical perspective that consistently integrates the notionsof institutional evolution and constitutional design.     

Some notes on trichotomous choice discrete valuation

For some respondents, the bid offered by the dichotomous choice format used in the discrete choice technique can in fact be the true optimum. In this case the correct answer is neither yes or no, but indifferent. We shall show results from a trichotomous choice format and analyse whether it produces welfare measures with narrower confidence intervals than the dichotomous technique. Another well known problem in contingent valuation (CV) studies is that the volume of the good to be purchased from hypothetical markets is not, in many cases, defined in precise terms. We show how the trichotomous choice technique can be used to test for possible vagueness in the volume of the project to be valued.     

Demographic variables in demand systems: The case for generality

This paper provides evidence in favour of greater generality in the demographic demand literature. We propose two demographic demand procedures. One extends the Gorman model by allowing non additive interaction between overheads and Barten scaling. The other extends Price Scaling, by allowing the equivalence scale to vary with utility, and offers a test of Equivalence Scale Exactness (ESE). The rejection of ESE is robust to the assumed demand functional forms (RNLPS, QAIDS), to items chosen, and the estimation method (MLE, GMM). The results show that published cell averages yield well determined estimates of the demographic generalisation parameters.This paper was written during my visit to the UBC in Vancouver, Canada in 1992/93. I am grateful to two anonymous referees for their helpful remarks on an earlier version. The disclaimer applies.     

Endogenous Growth and Natural Resource Scarcity

Endogenous growth theory has rekindled interest in the role of innovation in determining long-term economic growth. Generally, this body of literature has ignored the contribution of natural resources to growth or the role of innovation in overcoming resource scarcities. The latter problem has been a focus of resource economics for many years, but innovation is usually modelled as exogenous rather than endogenous technological change. Recent investigations in political economy have additionally suggested that the supply of innovation may itself be constrained by resource scarcities, especially in the developing world. The following paper attempts to bridge these theoretical gaps through the formal analysis of two issues: First, a simple Romer-Stiglitz model of endogenous growth with resource scarcity and population growth is developed to determine the optimal balanced growth path for the economy. Second, the basic model is extended to allow for the possibility of resource availability constraining the supply of innovation, so that in the long run innovation net of any resource constraint is zero. However, under the latter conditions it is still possible to avoid resource exhaustion and thus achieve a constant level of per capita consumption in the long run. The paper therefore demonstrates that endogenous growth can overcome resource scarcity, but the outcome in the long run depends critically on assumptions concerning any constraints imposed by resource availability on the generation of innovation.     

Information Cascades in the Labor Market

A model of herding behavior in the labor market is presented where employers receive signals with limited precision about the workers types, and can observe previous employers decisions. Both the employer and the worker can influence the signal probabilities. In particular, the employer tries to increase the precision of the signal about the workers type whereas the worker wants to get a good signal, independent of her type. In a two-period model, we derive conditions for an equilibrium in which only down-cascades occur, i.e., the second employer does not hire a worker with a bad history even if he receives a favorable private signal about the workers type, but he follows his own signal if the workers history is good.     

Managerial risk reduction, incentives and firm value

Summary. Empirical evidence suggests that managers privately alter the risk in their compensation by trading in the financial markets. This paper analyzes the implications of the managers hedging ability on her optimal compensation scheme, incentives and firm value. I allow the manager to reduce her systematic risk exposure by trading the market portfolio. I find that the managers optimal hedge depends on the liquidity of the market. Due to imperfect liquidity, the managers optimal hedge is not complete. The equilibrium pay-performance sensitivity and hence the managers equilibrium incentives and the firm value increases in the liquidity of the market.Received: 24 November 2003, Revised: 22 September 2004, JEL Classification Numbers: G30, G32.I am grateful to a referee whose comments improved the paper. I would also like to thank Gerald Garvey and Li Jin for their helpful comments on an earlier draft.     

The rational regulator's pricing response to enhanced opportunities to “bypass” the public telephone network

Various technological innovations make it profitable—given regulated service prices—for large business customers of local telephone companies to invest in private equipment and reduce their reliance on the public telephone network. Such bypass possibilities reduce demands and increase demand elasticities for regulated business services. The politics of state telephone regulation motivate two specifications of regulatory objectives—specifications designed to reveal positive implications of bypass for regulated prices. One views the regulator as practicing so-called residual pricing, and a generalization assumes that the regulator balances the interests of competing pressure groups. Implications for interpretation of political rhetoric and for future modeling are discussed.     

Natural resource accounting

There is as yet no consensus on the most appropriate way to incorporate the degradation of environmental capital into national income accounting procedure. Net product is currently derived by deducting from gross product the depreciation of man-made capital only. Deducting depreciation of natural capital in a similar manner will give a figure for true net product that provides a better indicator of that level of current income which is sustainable into the future. The user cost and net price methods of calculating the value of natural resource depreciation are analysed and assessed. On the basis of this assessment, the net price method is then used to adjust the national accounts of Zimbabwe for depletion of forests, soils and mineral resources, for the period 1980 to 1989. The results suggest that economic depreciation of natural resources represents approximately 2% of annual GDP, although this is regarded as a significant underestimate. The implications for integrating natural resource depletion into policy making, within the current national political climate, are then addressed.     

Privatizing Monopolies in Developing Countries: The Real Effects of Exclusivity Periods in Telecommunications

Many developing countries have given newly privatized incumbent network utilities, especially telecommunications, exclusive rights to serve particular markets. Research to date has explored privatization, competition, and to a lesser extent, regulation. We know little, however, about the effects of the privatization transactions themselves and, in particular, how these exclusivity periods matter. I use original data to investigate this approach to privatization. I find that exclusivity periods are associated with significant increases in the firms sale price. Exclusivity periods are also, however, correlated with a significant decrease in the incumbents investment in the telecommunications network, payphones, mobile telephone penetration, and international calling.JEL Classification: L1, L5, L96, O12I am grateful for the thoughtful comments and suggestions of Luke Haggarty, Tom Hazlett, Phil Keefer, Roger Noll, Russ Pittman, Greg Rosston, David Sappington, Mary Shirley, Lixin Colin Xu, and two anonymous referees. I thank Troy Kravitz for research assistance. I am solely responsible for all mistakes.