Contractual distortions in a market with frictions

This paper analyses contract design in a decentralized market environment with frictions. While principals (e.g., firms) have all contractual power, their market power is constrained as agents (e.g., workers) can choose to wait and search for better offers. We find that results depend crucially on how market frictions affect agents’ utilities. With type-independent costs of search and waiting, equilibrium contracts are always first-best. If agents are impatient and discount future payoffs, however, distortions vanish only gradually. In the latter case, we also characterize equilibrium offers and show that the market exhibits two types of externalities, both of which are absent in the case of type-independent costs of search.     

Nonstandard foundations of equilibrium search models

We develop an equilibrium sequential search model which includes most of the literature as special cases. In particular, the model can accommodate heterogeneity in buyers’ search costs and demand functions and firms’ cost functions, with general demand and cost functions. We identify conditions which ensure existence of equilibrium in pure strategies, utilizing recent progress in the theory of large games by Khan and Sun. These conditions elucidate the essential structure of equilibrium search models. Although we focus on sequential search, our methodology can be used for other classes of equilibrium search models as well.     

Alternative theories of wage dispersion

We analyze labor market models where the law of one price fails—i.e., models with equilibrium wage dispersion. We begin considering ex ante heterogeneous workers, but highlight a problem with this approach: If search is costly the market shuts down. We then assume homogeneous workers but ex post heterogeneous matches. This model is robust to search costs, and delivers equilibrium wage dispersion. However, we prove that the law of two prices holds: Equilibrium implies at most two wages. We explore other models, including one combining ex ante and ex post heterogeneity which is robust and delivers more realistic wage dispersion.     

Wage and price controls in the equilibrium sequential search model

In this paper, we study the effects of wage and price controls on employment, output, and welfare in a simplified version of the Bénabou (J. Econom. Theory 60 (1993) 140) equilibrium sequential search model with bilateral heterogeneity. We show that a price ceiling increases output but the change in welfare depends on three effects: the reduction in aggregate search costs, the increase in surplus due to increased output, and the transfer of production to the least efficient firm. The model is formally identical to a standard equilibrium search model of the labor market so analogous results hold for the minimum wage.     

Maximum likelihood estimation of search costs

In a recent paper Hong and Shum [2006. Using price distributions to estimate search costs. Rand Journal of Economics 37, 257-275] present a structural method to estimate search cost distributions. We extend their approach to the case of oligopoly and present a new maximum likelihood method to estimate search costs. We apply our method to a data set of online prices for different computer memory chips. The estimates suggest that the consumer population can be roughly split into two groups which either have quite high or quite low search costs. Search frictions confer a significant amount of market power to the firms: Despite more than 20 firms operating in each of the markets, we estimate price-cost margins to be around 25%. The paper also illustrates how the structural method can be employed to simulate the effects of the introduction of a sales tax.     

The Core, Transaction Costs, and the Coase Theorem

This paper clarifies and synthesizes elements of the two decade old debate concerning the Coase theorem and the empty core. Five lessons can be derived from this debate. First, the Coase theorem may break down when there more than two participants (provided the additional participants bring an additional externality to the table). Second, the problem of the empty core does not disappear in a world of positive transaction costs. Under reasonable assumptions about the transactions technology, transaction costs may well exacerbate the empty-core problem. As a consequence, it is important to differentiate between transaction costs (when the core exists) and costs due to the empty core because each has different implications for rationalizing institutional arrangements. Third, the Coase theorem will not break down when the number of participants increases if the new participants do not bring additional externalities with them. If, however, additional participants bring in additional externalities, then the core may be empty and Pareto efficiency may not emerge from costless negotiations. Fourth, Pareto Optimality can be achieved when the core is empty by judicious use of penalty clauses, binding contracts, and constraints on the bargaining mechanism. Fifth, when a non-excludable public good is involved, a free-rider problem arises as the number of agents increases, and this undermines the Coase theorem; in this case, Coasean efficiency requires the participation of all agents affected by the externality in the writing of binding contracts.     

Market thickness,sunk costs,productivity, and the outsourcing decision: an empirical analysis of manufacturing firms in France

Abstract This paper presents an empirical analysis of outsourcing behaviour by French manufacturing industries. It focuses on the effects of market thickness, sunk costs, and the productivity of firms on the outsourcing decision. I estimate a dynamic probit model where outsourcing decision is linked to past outsourcing behaviour. The results show that outsourcing is a persistent strategy adopted by large firms and suggest the presence of significant sunk costs associated with outsourcing. The results also show that market thickness reduces search costs and enhances the establishment of outsourcing relationships.     

THE WELFARE EFFECTS OF MANDATORY REEMPLOYMENT PROGRAMS: COMBINING A STRUCTURAL MODEL AND EXPERIMENTAL DATA

This article estimates a model of job search with utility costs and benefits triggered by mandatory reemployment programs. I use data from an experiment that generates exogenous variation in the threat of program participation and an increase in the job finding rate. I calculate the impact of the experiment on worker welfare, and find that participants would be willing to give up 1.5–1.7 weeks of unemployment benefits to avoid participation. These welfare costs vary across workers and are larger for workers with weaker employment prospects. Overall, welfare costs are substantial and therefore important to take into account.     

Search costs and efficiency: Do unemployed workers search enough?

Many labor market policies affect the marginal benefits and costs of job search. The impact and desirability of such policies depend on the distribution of search costs. In this paper, we provide an equilibrium framework for identifying the distribution of search costs and we apply it to the Dutch labor market. In our model, the wage distribution, job search intensities, and firm entry are simultaneously determined in market equilibrium. Given the distribution of search intensities (which we directly observe), we calibrate the search cost distribution and the flow value of non-market time; these values are then used to derive the socially optimal firm entry rates and distribution of job search intensities. From a social point of view, some unemployed workers search too little due to a hold-up problem, while other unemployed workers search too much due to coordination frictions and rent-seeking behavior. Our results indicate that jointly increasing unemployment benefits and the sanctions for unemployed workers who do not search at all can be welfare-improving.     

Search by committee

We consider the problem of sequential search when the decision to stop is made by a committee and show that a unique symmetric stationary equilibrium exists given a log concave distribution of rewards. We compare search by committee to the corresponding single-agent problem and show that committee members are less picky and more conservative than the single agent. We show how (i) increasing committee size holding the plurality fraction constant and (ii) increasing the plurality rule affect the equilibrium acceptance threshold and expected search duration. Finally, we show that unanimity is optimal if committee members are sufficiently patient.     

Agency conflicts in the presence of random private benefits from project implementation

We study a contracting problem where a principal delegates the decision to implement a “project” to an agent who obtains private information about the value of the project before making the implementation decision. Moral hazard arises because the agent gets private random non-contractible benefits, or incurs private random non-contractible costs, if the project is implemented. This contracting problem is pervasive, when “project” and “benefits” are interpreted broadly.     

Search costs and the severity of adverse selection

In view of some recent empirical evidence, I suggest a relationship between the magnitude of search costs and the severity of adverse selection in the context of a dynamic model with asymmetric information. In markets with small search costs sellers with low quality products misrepresent their quality and demand a high price. If search costs are not negligible, sellers׳ price offers are truthful and all product qualities are traded over time. In markets with small search costs, a budget balanced mechanism can mitigate adverse selection: sellers should pay a per period market participation tax and receive a rebate after trading.     

Efficiency in a search and matching model with training costs

This paper studies the efficiency of the search and matching model with training costs. I incorporate productivity enhancing firm-specific skill training into the search and matching model of Pissarides (2000). I demonstrate that while the decentralized economy can be efficient if training costs are not sunk at the time of wage determination, the decentralized economy is not efficient due to a hold-up problem if training costs are sunk.     

Competitively neutral universal service obligations

Universal service obligations impose specific costs on the universal service provider and the latter may call for an appropriate compensation. Most often, a two-step procedure is put forward to finance the universal service in a competitive environment. Firstly, the cost of the universal service is assessed; secondly, the provider must be compensated for this cost. We argue that this procedure is problematic because the implementation of a compensation scheme affects the behavior of market participants and leads to an overcompensation of the universal service provider. We put forward an alternative approach to this problem that fully acknowledges the distortions that result from the compensation mechanism.     

Trading mechanism selection with directed search when buyers are risk averse

We endogenize the trading mechanism selection in a model of directed search with risk averse buyers and show that the unique symmetric equilibrium entails all sellers using fixed price trading. Mechanisms that prescribe the sale price as a function of the realized demand (auctions, bargaining, discount pricing, etc.) expose buyers to the “price risk”, the uncertainty of not knowing how much to pay in advance. Fixed price trading eliminates the price risk, which is why risk averse customers accept paying more to shop at such stores.     

Moral hazard with bounded payments

We study the moral hazard problem with general upper and lower constraints M on compensation. We characterize the optimal contract and show existence and uniqueness. When minimizing costs for given effort, a principal harmed by M will pay according to M on some range of outcomes; when M reflects limited liability or a minimum wage, the contract is option-like. When the principal also chooses effort, a principal harmed by M might nonetheless never pay according to M. This cannot occur if the cost of inducing effort in the standard principal-agent problem is convex, for which we provide sufficient conditions related to the informativeness of outcome about effort.     

FOREIGN EXPERIENCES WITH MONETARY TARGETING: A PRACTITIONER'S PERSPECTIVE

Under certain conditions, monetary targets can reduce information costs and transaction costs to market participants. In international financial markets, these costs are associated with several types of risk which can influence the extent of international financial intermediation. During the 1970s, several factors seem to have prompted the trend toward targeting. The search by central banks for improved methods of inflation control was the primary factor. Targeting took a number of forms with respect to time periods, growth rates, and aggregates employed. In general, the experience with foreign monetary targeting to date probably has not lowered information costs or transactions costs to market participants, due to the extensive shifting between targets, changing of targeting time periods, and continual base drift. Such changes in targeting procedures along with the failure to hit targets tend to mask whether a change in monetary growth is temporary or permanent. The desire of foreign central banks to implicitly target exchange rates influences their ability to achieve monetary targets. The extent of this influence depends on the ability of foreign central banks to sterilize exchange market intervention.     

THE SECOND‐PRICE AUCTION SOLVES KING SOLOMON'S DILEMMA*

The planner wants to give k identical, indivisible objects to the top k valuation agents at zero costs. Each agent knows her own valuation of the object and whether it is among the top k. Modify the (k+ 1)st‐price sealed‐bid auction by introducing a small participation fee and the option not to participate in it. This simple mechanism implements the desired outcome in iteratively undominated strategies. Moreover, no pair of agents can profitably deviate from the equilibrium by coordinating their strategies or bribing each other.     

Consumer inertia, firm growth and industry dynamics

We develop a model of firm size, based on the hypothesis that consumers are “locked in,” because of search costs, with firms they have patronized in the past. As a consequence, older firms have a larger clientele and are able to extract higher profits. The equilibrium of this model yields: (i) A downward sloping density of firm sizes. (ii) Older firms are less likely to exit than younger firms. (iii) Larger firms spend more on R&D.     

Search frictions and labor market participation

Cross-country differences in labor market participation are often larger than differences in unemployment rates. The same holds true across demographic groups within a given economy. We argue that the interaction between labor force participation decisions and labor market frictions can help us understand these patterns. This interaction highlights dynamic aspects of the participation decision, in contrast to standard textbook treatments that emphasize static costs and benefits of participation. We extend the standard labor market search problem to allow for a third state—non-participation—and assumes that stochastic participation costs precipitate flows into and out of non-participation. We fully characterize the worker's decision problem and use numerical simulations to demonstrate how participation patterns vary with individual characteristics and with labor market conditions.