Salience and horizontal differentiation

I study a horizontal differentiation model in which one of two attributes of a product, product fit and price, is more salient for a consumer than the other and different consumers can find a different attribute salient. The attribute that is more salient is determined by relative differences between the two products and is determined endogenously as a result of firms' pricing strategies. High (low) marginal costs soften (toughen) price competition between firms. Pass-through rates are greater than 1 for some parameter values. Both industry- and firm-level cost increases may be beneficial for firms.     

Costly location in Hotelling duopoly

We introduce a cost of location into Hotelling׳s (1929) [9] spatial duopoly model. We derive the general conditions on the cost-of-location function under which a pure strategy price-location Nash equilibrium exists. With linear transportation cost and a suitably specified cost of location that rises toward the center of the Hotelling line, symmetric equilibrium locations are in the outer quartiles of the line, ensuring the existence of pure strategy equilibrium prices. With quadratic transportation cost and a suitably specified cost of location that falls toward the center of the line, symmetric equilibrium locations range from the center to the end of the line.     

Endogenous Persuasion with Costly Verification

In this paper, I study a situation in which a sender tries to persuade a receiver with evidence that is generated via public or private experimentation. Under public experimentation, any experimental outcome is revealed, and under private experimentation the sender can hide adverse outcomes. The sender can design the properties of the experiments. The receiver chooses whether to verify at a cost the design of the experiment with which the revealed outcome was generated. I find that communication breaks down under public experimentation if there is no restriction on the experiment's design, and that persuasion is possible under private experimentation.     

Costly optimizers versus cheap imitators

A dynamic model is constructed with two types of agents, optimizers and imitators. The mix between the two types evolves according to the relative average performances of the two groups. The main conclusion is that imitators may have as high a long-run ‘fitness’ as optimizers. The model is used to sort issues concerning the conventional hypothesis that everyone acts as if unboundedly rational.     

Costly switching and investment volatility

Summary. This paper extends the literature on the optimal switching rule between two investments by considering the case where switching between investments is costly. The model builds on the classic framework of the multi-armed Bandit problem by explicitly incorporating two key assumptions. First, switching investments is costly. Second, only the investment operated by the investor evolves as a random walk. The objective of the investor is to maximize the discounted sum of expected net profits over the infinite horizon. The main result is that when the volatility of profits from investments increases, so does the minimum profit gain needed for an investor to switch investments.JEL Classification Numbers: C44, C61.I am indebted to Prajit K. Dutta for his guidance throughout this research. I am grateful for Presidents Summer 2000 Research Fellowship of Columbia University. I appreciate the comments from the anonymous referee. I also thank Lalith Munasinghe and Rajiv Sethi. I also thank Dr. Jong Myeon Kim for editing this version of the paper.     

Costly Enforcement of Voluntary Environmental Agreements

We examine the consequences of costly enforcement on the ability of voluntary agreements with industries to meet regulatory objectives, the levels of industry participation with these agreements, and the relative efficiency of voluntary and regulatory approaches. A voluntary agreement can be more efficient in reaching an aggregate emissions target than a conventional emissions tax, but only if: (1) profitable voluntary agreements in which members of the agreement pay for its enforcement exist; (2) members of a voluntary agreement actually bear the costs of enforcing the agreement; (3) the agreement is enforced by a third-party, not the government, and (4) this third-party enforcer has a significant advantage in monitoring technology and/or available sanctions over the government.     

Capital Structure under Costly Enforcement*

We consider financial structure and repayment behavior in a setting where cash flows are private information to the entrepreneur and the cost of enforcing repayment differs across security holders. If enforcement costs are lower for shareholders than for creditors, a mixed capital structure with debt and equity can obtain in equilibrium. Under a mixed capital structure, creditors intervene in low cash‐flow states while shareholders intervene in high cash‐flow states. Moreover, strategic defaults, costly bankruptcy, shareholder intervention, and violation of absolute priority occur with positive probability on the equilibrium path. Several of the predictions from our framework are consistent with evidence not readily explainable by existing theories.     

Taxation when Borrowing is Costly*

The implications for taxation theory of a life-cycle model of consumption incorporating financial transactions costs are derived The equity case for progressive taxation is shown to correspond in a life-cycle setting, to an efficiency case. Individuals prefer a progressive tax system to a proportional one because the tax burden is lower when they are young and face high transactions costs of borrowing. Similarly, an income tax is preferred to a consumption tax. Unlike earlier models based on liquidity constraints, the model presented here involves a financial sector consuming real resources. This permits analysis of the tax treatment of financial services in a consumption tax system. Exemption of financial services will generally be desirable.     

Costly structural change and optimal growth

Summary This paper studies the optimal growth of a developing economy that has a choice to expend a fixed amount of resource for a structural change that advances its production technology. It is shown that structural change is undertaken if capital stock is above a critical level. Economies undertaking structural change converge to a larger steady state and economies not undertaking structural change converge to a smaller steady state. The optimal policy correspondences and growth paths are characterized. The social optimum is shown implementable by a competitive equilibrium with lump-sum taxation.We are grateful to Francis Cheung, Carmen Menezes, Peter Mueser, Don Schilling, two anonymous referees and an associate editor for their valuable suggestions.     

International Pricing with Costly Consumer Arbitrage

Consumer arbitrage affects international pricing in several ways. If all consumers face the same arbitrage costs, a monopolist's profit increases with arbitrage costs, and world welfare declines with them (if output does not rise). If arbitrage costs differ across consumers, a monopolist may sell in a second country even if there is no local demand—it can use the second country to discriminate across consumers in the first country. Again, world welfare typically falls with arbitrage costs. When there is also local demand in the second country, world welfare may be increasing in arbitrage costs, even if output falls.     

Costly Tax Enforcement and Financial Repression

Using an overlapping generations production‐economy model characterized by financial repression, purposeful government expenditures and cost of tax collection, we analyse whether financial repression can be explained by the cost of raising taxes. We show that with public expenditures affecting utility of the agents, modest costs of tax collection tend to result in financial repression being pursued as an optimal policy by the consolidated government. However, when public expenditures are purposeless, the above result only holds for relatively higher costs of tax collection. But, more importantly, costs of tax collection cannot produce a monotonic increase in the reserve requirements. What are critical, in this regard, are the weights the consumer assigns to the public good in the utility function and the size of the government.     

Costly capital reallocation and energy use

In time series data, energy use does not change much with energy price changes. However, energy use is responsive to international differences in energy prices in cross-section data across countries. In this paper we consider a model of energy use in which production takes place at individual plants and capital can be used either to directly produce output or to reduce the energy required to run the plant. We assume that reallocating capital from one use to another is costly. This turns out to be crucial for the quantitative properties of the model to be in conformity with the low short-run and high long-run elasticities of energy use seen in data.     

Costly Technology Adoption and Capital Accumulation

We develop a model of costly technology adoption where the cost is irrecoverable and fixed. Households must decide when to switch from an existing technology to a new, more productive technology. Using a recursive approach, we show that there is a unique threshold level of wealth above which households will adopt the new technology and below which they will not. This threshold is independent of preference parameters and depends only on technology parameters. Prior to adoption, households invest at increasing rates, but consumption growth is constant.     

Regulatory Compliance with Costly and Uncertain Litigation

Harrington (1988) and more recent papers by Heyes and Rickman (1999), Livernois and McKenna (1999), and Heyes (1996) have attempted to explain how a relatively large fraction of firms are thought to be in compliance with environmental regulations despite the fact that expected penalties for these violations are deemed rather low. This paper offers an alternative explanation for the interesting paradox by incorporating costly and uncertain litigation.     

The Law and Economics of Costly Contracting

In most of the contract theory literature, contracting costsare assumed either to be high enough to preclude certain formsof contracting or low enough to permit any contract to be written.Similarly researchers usually treat renegotiation as eithercostless or prohibitively costly. This article addresses themiddle ground between these extremes, in which the costs ofcontracting and renegotiation can take intermediate values andthe contracting parties can themselves influence these costs.The context for our analysis is the canonical problem of inducingefficient relation-specific investment and efficient ex posttrade. Among our principle results are: (i) The efficiency andcomplexity of the initial contract are decreasing in the costto create a contract. Hence the best mechanism design contractscan be too costly to write. (ii) When parties use the simplercontract forms, they require renegotiation to capture ex postsurplus and to create efficient investment incentives. In somecases, parties want low renegotiation costs. More interestingis that, in other cases, parties have a strict preference formoderate renegotiation costs. (iii) The effect of contract lawon contract form is significant but has been overlooked. Inparticular, the law's interpretive rules raise the cost of enforcingcomplex contracts, and thus induce parties to use simple contracts.Worse, the law also lowers renegotiation costs, which furtherundermines complex contracts and is also inappropriate for someof the simpler contracts.     

Costly Coasean Bargaining and Property Right Security

This paper examines how transaction costs affect Coasean bargaining with secure and insecure property rights in the lab. Consistent with the theory that secure property rights lowers the cost of non-cooperation, we find that bargaining efficiency is inversely related to property right security. Less secure property rights increased economic efficiency twofold. Property owners with secure rights are more likely to opt for their riskless outside option rather than pay the costs of bargaining.     

Costly financial intermediation and excess consumption volatility

This paper documents the cyclical properties of financial intermediation costs and uses their dynamics to explain excess consumption volatility (ECV) differences across countries in a dynamic stochastic general equilibrium framework with housing market. I find that financial development levels have a limited role in explaining ECVs. Instead, the volatility of financial sectors plays the determinative role. Consistent with the data, the model finds higher ECVs in emerging countries. The paper also shows that if the US had the same intermediation cost structure as Turkey, deteriorations in the production and consumption following a financial shock would increase threefold.     

Tariff Wars and Trade Deals with Costly Government

The authors study a simple model of tariff wars and trade deals in which government revenue collection and disbursement uses resources. The introduction of costly governments leads to lower non‐cooperative tariffs, the possibility that a less costly government may win a tariff war, and fully cooperative trade deals where countries lower tariffs but do not eliminate them, even with lump‐sum taxes and transfers.