The optimality of nominal contracts

Summary. This paper presents a model in which agents choose to use money as a medium of exchange, a means of payment, and a unit of account. The paper defines conditions under which nominal contracts, promising future payment of a fixed number of units of fiat money, prove to be the optimal contract form in the presence of either relative or aggregate price risk. When relative prices are random, nominal contracts are optimal if individuals have ex ante similar preferences over future consumption. When the aggregate price level is random, whether from shocks to the money supply or aggregate output, nominal contracts (perhaps coupled with equity contracts) lead to optimal risk-sharing if individuals have the same degree of relative risk aversion. Finally, nominal contracts may be optimal if the repayment of contracts is subject to a binding cash-in-advance constraint. In this case, a contingent contract increases the risk of holding excessive cash balances. Received: March 29, 1996; revised version: February 25, 1997     

Monopoly Price Dispersion Under Demand Uncertainty

When a monopolist sets its price before its demand is known, then it may set more than one price and limit the availability of its output at lower prices. This article adds demand uncertainty and price rigidities to the standard model of monopoly pricing. When there are two states of demand and the ex post monopoly price is greater when demand is high then the monopolist's optimal ex ante pricing strategy is to set two prices and limit purchases at the lower price.     

Optimal pricing of a two-sided monopoly platform with a one-sided congestion effect

This paper studies the optimal pricing of a two-sided monopoly platform when one side is affected by congestion. We show that the divide-and-conquer pricing strategy (or skewed pricing) depends not only on the relative magnitude of the sides’ price elasticities of demand but it also depends on the marginal congestion cost that an agent imposes on the others. Compared with the no-congestion case, this pricing strategy gives rise to some interesting features that violate the results of Rochet and Tirole (J Eur Econ Assoc 1:990–1029 in 2003, Rand J Econ 37:645–667 in 2006). In the case of equal price elasticities of demand, the no-congested side is charged the highest price. On the other hand, in the case of different price elasticities, the platform congestion pricing depends on a certain threshold of the marginal congestion cost. We show, under some conditions, that the divide-and-conquer pricing strategy is reversed. In the social context, the Rochet and Tirole’s (J Eur Econ Assoc 1:990–1029 in 2003) cost allocation condition is modified by the congestion cost. We show that the congestion does not only affect the buyers’ contribution to the sellers’ surplus, but it also affects the sellers’ contribution to the buyers’.     

Dynamic demand and noncompetitive pricing strategies

This paper studies optimal noncompetitive pricing strategies when the evolution of demand is the result of intertemporal considerations. Two different hypotheses of price expectations (myopia and perfect foresight) are treated. The major implication is that the slight modification from an instantaneous to a very fast consumer reaction may completely modify a monopolist's price strategy. More precisely, the price strategy should be volatile if the equilibrium demand is convex, independent whether the consumers act myopically or employ rational expectations. On the other hand, asynchronous dynamics (e.g., due to competitive fringe supply or different segments of demand) cannot explain even damped price oscillations. The equilibrium price strategy of the noncompetitive supplier exceeds the static rule if consumers employ myopic expectations; rational expectations may lead to prices above or below the static rule depending on the rate of discount.I am grateful for the helpful and elaborate comments from three anonymous referees.     

Forecasting house prices for the four census regions and the aggregate US economy in a data-rich environment

This article considers the ability of large-scale (involving 145 fundamental variables) time-series models, estimated by dynamic factor analysis and Bayesian shrinkage, to forecast real house price growth rates of the four US census regions and the aggregate US economy. Besides the standard Minnesota prior, we also use additional priors that constrain the sum of coefficients of the VAR models. We compare 1- to 24-months-ahead forecasts of the large-scale models over an out-of-sample horizon of 1995:01–2009:03, based on an in-sample of 1968:02–1994:12, relative to a random walk model, a small-scale VAR model comprising just the five real house price growth rates and a medium-scale VAR model containing 36 of the 145 fundamental variables besides the five real house price growth rates. In addition to the forecast comparison exercise across small-, medium- and large-scale models, we also look at the ability of the ‘optimal’ model (i.e. the model that produces the minimum average mean squared forecast error) for a specific region in predicting ex ante real house prices (in levels) over the period of 2009:04 till 2012:02. Factor-based models (classical or Bayesian) perform the best for the North East, Mid-West, West census regions and the aggregate US economy and equally well to a small-scale VAR for the South region. The ‘optimal’ factor models also tend to predict the downward trend in the data when we conduct an ex ante forecasting exercise. Our results highlight the importance of information content in large number of fundamentals in predicting house prices accurately.     

The Bank Lending Channel and Monetary Policy Rules: Evidence from European Banks

There exist two main channels of the monetary transmission mechanism: the interest rate and the bank lending channel. This paper focuses on the latter, which is based on the central bank’s actions that affect loan supply and real spending. The supply of loans depends on the monetary policy indicator, which, in most studies, is the real short-term interest rate. The question investigated in this paper is how the operation of the bank lending channel changes when this short-term indicator is allowed to be endogenously determined by the target rate the central bank sets through a monetary rule. We examine the effect that a rule has on the bank lending channel in European banking institutions spanning the period 1999–2009. The expectations concerning inflation and output affect the decision of the central bank for the target rate, which, in turn, affect private sector’s expectations —commercial banks— by altering their loan supply.     

Ex Post Welfare under Alternative Health Care Systems

The implications of a societal aversion to inequality for the optimal structure of the health care system are studied. The agents are assumed to be ex ante identical, but to differ ex post in the state of their health. Inequality aversion is introduced by postulating a strictly concave ex post social welfare function. It is shown that the optimal public health care system allocates health care differently than would private health insurance; specifically, people who are relatively unhealthy with and without treatment receive more health care, and people who are relatively healthy with and without treatment receive less health care. The aggregate quantity of health care under the optimal public health care system can be either greater or smaller than under private health care insurance. If the public health care system is optimally designed, allowing agents to purchase supplementary private health care insurance cannot raise social welfare and is likely to decrease it.     

Entrepreneurial competition and its impact on the aggregate economy

This paper models entrepreneurship as the entrepreneur’s information processing activity in order to predict changes in demand and reallocate resources. The results show that allocative efficiency—and therefore aggregate productivity—increases through intensified competition by entrepreneurs grasping at opportunities. This fierce competition leads to price reductions that result in the improvement of measured aggregate productivity. The price reduction also forces relatively less able entrepreneurs to become workers. As resources are then dealt with only by relatively talented entrepreneurs, this selection effect also increases aggregate productivity. The paper also discusses how the selection effect influences the distribution of firm size.      

The Role of Governments in Aligning Functional Income Distribution with Full Employment

Demand is an incentive for investment. The latter is necessary to create employment. If demand lags behind supply, then unemployment and underemployment rise. Persistent unemployment and underemployment indicate a dysfunctional price mechanism. Then, only governments can stimulate demand. They may equalize ex ante saving and investment by public investment, income redistribution, or market regulation.     

累积创新中的内生许可证

This paper analyzes the endogeneity of licensing arrangements in cost-reducing cumulative innovation. There exists the following results. First, for the first-generation patentee, ex post licensing matters for rent extraction while ex ante licensing matters for efficiency. Second, if the second-generation innovator does not exit, then the firms’ profits as well as social welfare are all irrelevant to whether ex ante licensing is allowed. Third, costly litigation can occur on the equilibrium path and its occurrence is also irrelevant to ex ante licensing. Interestingly, the conditional probability of the first-generation patentee winning litigation first decreases and then increases in patent breadth. Fourth, optimal patent breadth depends on the tradeoff between litigation costs and antitrust effect. Translated from Shijie Jingji Wenhui 世界经济文汇 (World Economic Papers), 2006, (6): 1–29     

Pricing inputs to induce efficient Make-or-Buy decisions

We investigate input pricing regimes that induce efficient Make-or-Buy decisions by entrants when there is constant returns in the production of the input(s) and simultaneous noncooperative price competition in downstream retail markets. Necessary and sufficient conditions for efficient Make-or-Buy decisions are derived. The necessary condition shows that input prices are relevant for Make-or-Buy decisions except under restrictive and often unverifiable assumptions on the demand structure, and that the least informationally-demanding way to ensure efficient Make-or-Buy decisions is to price inputs at marginal cost provided changes in the entrant’s cost have a “normal” effect on the entrant’s profit. The conditions also show that pricing the incumbent’s input at the entrant’s marginal cost always ensures efficient Make- or-Buy decisions. The extent to which input prices can depart from marginal cost while still inducing efficient Make-or-Buy decisions increases with the efficiency differential between the incumbent and entrant and with the demand displacement ratio.      

Effective Demand: Securing the Foundations

Abstract

This paper is one of three contributions to a symposium commenting on papers previously published by the other authors. Allain (Allain, O. (2009) Effective demand and short-term adjustments in the General Theory, Review of Political Economy, 21, pp. 1–22) argues that Keynes elides a distinction between aggregate demand and global expenditure that is necessary to explain the formation of price expectations by individual entrepreneurs. Allain's conclusions depend upon redefinitions of aggregate and effective demand and the consumption function. Hartwig (Hartwig, J. (2007) Keynes vs. the Post Keynesians on the principle of effective demand, European Journal of the History of Economic Thought, 14, pp. 725–739) argues that entrepreneurs must take into account the state of the economy as a whole, in order to form price expectations independently and not as a market equilibrium determined by aggregate supply and demand. This leaves demand price expectations to be determined outside the principle of effective demand. Neither author does full justice to Keynes's own treatment. We still need to agree by what mechanism individual entrepreneurs form a collective and mutually consistent state of expectation in The General Theory.     

Price cap regulation of a dominant firm facing competition

Price cap regulation is typically applied to natural monopolies operating with subadditive costs. Price caps are known to provide superior incentives for the regulated monopoly to pursue cost reduction and, in a multiservice/product context, undertake welfare enhancing price discrimination. It is well known that capping a Laspeyres index of the firm’s prices induces the monopoly to charge socially optimal “Ramsey” prices in the long run. This paper examines the suitability of the Laspeyres form of regulation when the regulated firm faces competition in the market for one of its services (outputs). We present the appropriately modified Ramsey pricing rule for the regulated dominant firm and demonstrate that capping a Laspeyres index of the dominant firm’s prices leads to prices that satisfy this pricing rule in the long run.     

An Incentive Water Pricing Policy for Sustainable Water Use

By adopting the Water Framework Directive (WFD), the European Commission (EC) and the European Council made recommendations for water pricing policies in European Union (EU) member states with a view to enhancing the sustainability of water resources. Clearly, the directive integrates economic instruments in environmental policies to provide incentives for the sustainable use of water resources. Our analysis will focus on public water utilities, required to be financially self-sufficient, facing demand and capacity shocks. The paper deals with the simultaneous determination of incentive pricing policies and investment rules under an ex~ante maximum demand charge. We will characterize the welfare-optimal capacity selection rule and the welfare-optimal maximum demand pricing rule. Heterogeneous consumers demands are considered when tariffs are set ex~ante, before demands are known. Our results are state-contingent nonlinear pricing that responds to demand fluctuations and capacity constraints.      

The origins of meso economics

The paper starts from Schumpeter’s proposition that entrepreneurs carry out innovations (the micro level), that swarms of followers imitate them (meso) and that, as a consequence, ‘creative destruction’ leads to economic development ‘from within’ (macro). It is argued that Schumpeter’s approach can be developed into a new—more general—micro-meso-macro framework in economics. Center stage is meso. Its essential characteristic is bimodality, meaning that one idea (the generic rule) can be physically actualized by many agents (a population). Ideas can relate to others, and, in this way, meso constitutes a structure component of a ‘deep’ invisible macro structure. Equally, the rule actualization process unfolds over time—modelled in the paper as a meso trajectory with three phases of rule origination, selective adoption and retention—and here meso represents a process component of a visible ‘surface’ structure. The macro measure with a view to the appropriateness of meso components is generic correspondence. At the level of ideas, its measure is order; at that of actual relative adoption frequencies, it is generic equilibrium. Economic development occurs at the deep level as transition from one generic rule to another, inducing a change of order, and, at the surface level, as the new rule is adopted, destroying an old equilibrium and establishing a new one.     

THE AD-AS MODEL AND ITS SOLUTIONS: SOME NEW RESULTS IN A DISEQUILIBRIUM PERSPECTIVE*

This paper discusses the logical foundation and the solutions of a microfounded aggregate demand … aggregate supply model under the disequilibrium hypothesis. We first show that a) the latter hypothesis is the only one ensuring model consistent expectations and that b) price predetermination, more than price flexibility, should be embodied in an AD-AS framework. Then we develop a full AD-AS scheme, both under excess supply and excess demand for labour. We prove that in the latter case no well defined equilibrium exists. Finally, we discuss stability and perform some comparative statics exercises.     

Voluntary Contributions to a Mutual Insurance Pool

We study mutual‐aid games in which individuals choose to contribute to an informal mutual insurance pool. Individual coverage is determined by the aggregate level of contributions and a sharing rule. We analyze theoretically and experimentally the (ex ante) efficiency of equal and contribution‐based coverage. The equal coverage mechanism leads to a unique no‐insurance equilibrium while contribution‐based coverage develops multiple equilibria and improves efficiency. Experimentally, the latter treatment reduces the amount of transfers from high contributors to low contributors and generates a “dual interior equilibrium.” That dual equilibrium is consistent with the co‐existence of different prior norms which correspond to notable equilibria derived in the theory. This results in asymmetric outcomes with a majority of high contributors less than fully reimbursing the global losses and a significant minority of low contributors less than fully defecting. Such behavioral heterogeneity may be attributed to risk attitudes (risk tolerance vs risk aversion) which is natural in a risky context.     

Uncertainty,Learning and Heterogeneity in International Environmental Agreements

This paper concerns the formation of International Environmental Agreements under uncertainty about environmental damage with different models of learning (complete learning, partial learning or no learning). The results of the existing literature are generally pessimistic: the possibility of either complete or partial learning generally reduces the level of global welfare that can be achieved from forming an IEA relative to no learning. That literature regards uncertainty as a parameter common to all countries, so that countries are identical ex ante as well as ex post. In this paper we extend the literature to the case where there is no correlation between damage costs across countries; each country is uncertain about a particular parameter (in our case the benefit-cost ratio) drawn from a common distribution but, ex post, each country’s realized parameter value is independently drawn. Consequently, while countries remain identical ex ante, they may be heterogeneous ex post. We show that this change reinforces the negative conclusions about the effects of partial learning on international environmental agreements, but, under certain conditions, moderates the negative conclusions about the effects of complete learning.     

Relative risk aversion, relative prudence and comparative statics under uncertainty: The case of (μ, σ)‐preferences

From the expected‐utility approach, relative risk aversion being smaller than one and relative prudence being smaller than two emerge as preference restrictions that fully determine the optimal responses of decisions under uncertainty to certain shifts in probability distributions. We characterize the magnitudes of relative risk aversion and relative prudence in terms of the two‐parameter, mean‐standard deviation approach. We demonstrate that this characterization is instrumental in obtaining comparative static results in the two‐parameter setting. We further relate our findings to the results in the expected‐utility framework.