Sector-specific capital, “Bang-bang” investment,and the Filippov solution

Bang-bang investment in a two-sector growth model with immobile capital is rational and leads to a unique and globally stable long-run equilibrium along a sliding trajectory. This steady state coincides with the stationary equilibrium in the traditional model with non-sector-specific capital.This article was written while the authors were visiting scholars at Cornell University. We gratefully acknowledge financial assistance from the Erasmus University Trust Fund and the Netherlands Scientific Organization. We would like to thank, without implicating, two anonymous referees, Martijn Herrmann, Jean-Marie Viaene, Claus Weddepohl, and the participants of seminars at the University of Maryland, the University of Montreal, and Erasmus University Rotterdam for perceptive remarks and useful comments. Jeroen Hinloopen and Rien Wagenvoort provided able graphical assistance. The views expressed in this article are those of the authors and not necessarily those of the World Bank.     

Agency in a market setting

This paper examines a market in which a continuum of principals and agents interact in a game. Principals offer contracts while agents decide on sets of acceptable contracts. A mechanism from a class satisfying efficiency, unbiasedness, and continuity properties then matches principals and agents. With risk neutral agents, when the contribution of principals and agents to the total gains from trade in a pairing are additively separable, the equilibria of the game coincide with the competitive equilibria for the market. In particular, all contracts used in Nash equilibrium induce first-best effort levels. Both principals and agents have exogenous opportunities outside this market. In equilibrium, agents have endogenously determined outside opportunities available from employment by another principal, and this may be the binding participation constraint in a principal-agent pairing. The results are extended to special non-separable cases and to the case of identical risk averse agents.We are grateful to seminar participants at Indiana University, the University of Kentucky, and Vanderbilt University for comments on earlier versions of this work. Referees' comments led us to generalize the model and to more clearly specify the point of the paper.     

Dynamic coordination games

Summary Gains from coordination provide incentives for delay. In this paper, the extent of delay is studied in a dynamic,N-person, coordination game. There is no social gain from delay, so an equilibrium with delay is always inefficient. For fixedN, there is no coordination failure when the period length is short: all equilibrium outcomes converge to the Pareto efficient outcome as the period length converges to zero. On the other hand, holding period length fixed, there exist equilibria in which delay is proportional toN, for arbitrarily large values ofN. In addition, it can be shown that the possibility of delay depends on the timing of strategic complementarities. However, under certain conditions, delay is shown to be a robust phenomenon, in the sense that well-behaved equilibria exhibit infinite delay forN sufficiently large.This paper grew out of discussions with Christophe Chamley. While writing it I benefited from discussions with Ken Binmore, Russell Cooper, Bob Rosenthal and Michael Manove. Joe Farrell, Drew Fudenberg, Martin Hellwig and Sawoong Kang made very useful comments on an earlier version that led to substantial improvements. Helpful comments were also made by seminar participants at the London School of Economics, the SUNY at Stoney Brook, the NBER Summer Institute, Northwestern University, and the University of Chicago. I would like to thank Nick Yannelis and an anonymous referee for their editorial advice. Financial support for this research was provided by the National Science Foundation under Grant No. SES 9196061.     

From “tax state” to “debt state”

The paper is motivated by Joseph A. Schumpeter's The Crisis of the Tax State. It inquires whether the buildup of government debt in peacetimeprosperity is a threat to the stability, existence or creation of viable tax states. The paper begins by setting out Schumpeter's conception of the tax state and the nature of recent political-economic events which have reinvigorated the concept. Next the paper sets out some simple debt dynamics and sketches a debt-induced business cycle arising from heavy reliance on debt finance in peacetimeprosperity. Finally, the paper assesses threats to the tax state in light of recent work on path dependence and positive feedback. An attempt is made to throw some light on whether the plethora of new, and often small, states spawned by the demise of communism can be viable tax states.Essay on Government, the Tax State and Economic Dynamics submitted to the Third Schumpeter Prize Competition.     

Fully endogenous mechanism selection on finite outcome sets

Summary This paper defines a choice process over social outcomes in which agents choose the institutional rules ormechanisms themselves without outside interference. Truly endogenizing the mechanism selection process in this way, however, involves facing an infinite regress problem in which outcomes are chosen by games which are themselves chosen by games, ad infinitum. This paper allows the possibility of such an infinite regress which we callfully endogenous mechanism selection.We introduce the notion ofFree Choice which restricts the class of mechanisms in the regress to those which prevent agents from being locked in to an equilibrium outcome by the actions of others. Under this condition, the infinite regress is shown to get truncated with the number of selection iterations endogenously determined. It turns out that the outcomes resulting from a Free Choice-constrained regress are (Weakly) Pareto optimal; in particular, these outcomes solve a weighted Rawlsian Maxmin criterion. We also show that these outcomes are invariant to the equilibrium concept used to evaluate games in the regress.This paper is based on the author's dissertation from the University of Minnesota (November, 1989).I am very grateful for the guidance, advice, and encouragement from my advisor, Marcel K. Richter, and for the many helpful suggestions from David Levine. I have also benefited from conversations with Nabil Al-Najjar, Gerhard Glomm, Leonid Hurwicz, James Jordan, Ramon Marimon, Andrew McClennan, Ariel Rubinstein, and William Thomson.     

Regulating a monopolist with limited funds

Summary. We consider the problem of regulating a monopolist with unknown costs when the regulator has limited funds. The optimal regulatory mechanism satisfies four properties. The first property is bunching at the top, that is the more efficient types produce the same quantity irrespective of their costs. The second property is separability of less efficient types. The third property is full bunching of types when the available fund is small enough. The fourth property of the mechanism is that it is a third best one, that is, the output under this regulatory mechanism is strictly lower than the second best output for any given type.Received: 14 June 2004, Revised: 31 August 2004, JEL Classification Numbers: D82, H42, L51. Correspondence to: Manipushpak MitraThe authors would like to thank Georg Nöldeke for encouraging this work. The authors are also thankful to Debajyoti Chakrabarty, Sougata Poddar and one anonymous referee for helpful comments and important suggestions. The authors gratefully acknowledge the financial support from the Deutsche Forschungsgemeinschaft Graduiertenkolleg (DFG) 629 at the University of Bonn and from the Brussels Capital Region. The authors would like to thank the seminar participants at the EEA Conference 2003 (Stockholm), at the Indian Statistical Institute (New Delhi and Kolkata), at the Jadavpur University (Kolkata) and at the Centre for Studies in Social Sciences (Kolkata). The authors are solely responsible for the errors that may remain. An earlier version of this paper was called Financing infrastructure under budget constraints. Since the applicability of the problem developed in the earlier version is not limited to infrastucture, in this vers ion we have changed the name and content to incorporate this generality.     

Labour market institutions and the industry wage distribution

The paper studies the industry wage structures of Austria, Norway, the union sector of the U. S. as well as the non-union sector of the U. S. We make comparable regressions for each country, and are thus able to compare the sectoral earnings patterns controlling for the usual individual characteristics. Our results confirm the hypothesis that the pattern of the inter-industry pay structure is largely independent of labour market institutions: High paying industries in a non-union environment tend to pay high wages also in regimes where bargaining is very centralised and coordinated.This, however, does not mean that collective bargaining does not matter. The influence is mainly on the amount of wage dispersion: We find considerably lower industry pay gaps in centralised Austria and Norway than in decentralised U. S. Within the U. S., pay differentials within the union sector slightly exceed those of the non-union sector.The results give support to non-competitive explanations of the labour market. If efficiency wage mechanisms are the reason for wage differentials we expect central bargainers to internalise these effects. Competitive explanations, on the other hand, would predict no difference between the non-union outcome and a central agreement aiming at achieving full employment.This work was conducted while we were both affiliated with the University of California at Berkeley, and we thank the Institute of Industrial Relations at the University of California, Berkeley, for its support and hospitality. The research was supported by the Austrian Fonds zur Förderung der wissenschaftlichen Forschung under the project JO548-SOZ (Zweimüller) and the Norwegian NORAS under the LOS program (Barth). A preliminary version of the paper was presented at the Labour Seminar at the University of California, Berkeley. We thank the participants, especially Bill Dickens and Jonathan Leonard for valuable comments. We are indebted to Bill Dickens also for giving us access to the U. S. data set CPS 1983. Thanks also to Herbert Walther for useful comments.     

Predation and reputation acquisition in debt markets

This paper presents a model of predation based on reputational differences between the entrant and an incumbent. While the incumbent has an established reputation in the debt market, the entrantss quality is not yet known in the debt market. We show that the incumbent may have incentives to prey in order to interfere with the reputation acquisition of the entrant.Received: June 2002 , Accepted: December 2002, JEL Classification: C72, D82, G3, L1I am grateful to one anonymous referee for very valuable comments. In addition, for helpful comments on previous versions of this paper, I thank Drew Fudenberg, Jean Tirole, António Pires, Soumodip Sarkar, and seminar participants at M.I.T., Boston University and Western Ontario University.     

Vertical and Horizontal Trust Networks in Bureaucracies: Evidence from the Third Reich

In a seminal contribution to the literature on bureaucracy, Breton and Wintrobe (The Logic of Bureaucratic Conduct: An Economic Analysis of Competition, Exchange, and Efficiency in Private and Public Organization. New York, NY: Cambridge University Press, 1982) develop a model wherein subordinates and superiors in a bureaucratic structure trade with each other to advance the objectives of the superiors. The success of such an organizational arrangement (for superiors) is based upon the development of vertical trust networks in a way that facilitates the promise of informal payments by superiors in return for informal services provided by their subordinates. Breton and Wintrobe [Journal of Political Economy 94 (1986) 905] also provide a theoretical application of their model by describing the Nazi bureaucracy as a conglomeration of competing agencies that zealously carried out the Final Solution to the Jewish question. As an extension, this note develops two compelling empirical examples of vertical and horizontal trust networks within the Nazi regime: Einsatzgruppen As (Special Action Detachments) attempt to liquidate all Lithuanian Jews after the German invasion of the U.S.S.R. in 1941 and the 20 July 1944 attempt to assassinate Adolf Hitler.JEL Classification: D23, D73.     

Price leadership in a duopoly with capacity constraints and product differentiation

This paper analyzes Stackelberg price leadership in a duopoly in which firms are capacity constrained and products are imperfect substitutes. Assuming symmetric substitutes, linear demand, and efficient rationing, we characterize the equilibria with an exogenously specified leader. Using the equilibrium profits derived from these games, we argue that over certain ranges of asymmetric capacities an endogenous price leader will emerge. When endogenous leadership does arise, it is the large capacity firm which is the leader. We thus provide a game theoretic model of dominant firm price leadership.Dave Furth's research has been undertaken as a part of the project Competition and Cooperation. Dan Kovenock has benefited from financial support from Erasmus University Rotterdam, the Krannert School of Management, and the Jay N. Ross Young Faculty Research Fellowship. We are grateful to Tom Faith for valuable research assistance. We have benefited from the comments of the editor, two anonymous referees, and participants at the European meetings of the Econometric Society in September 1989 and the North American Winter Meetings of the Econometric Society in December 1989.     

Ramsey pricing and competition: The consequences of myopic regulation

This paper addresses the welfare consequences of applying the Ramsey rule when the regulated firm is not a monopolist in all of its markets. The partially regulated optimum and the outcome of myopic regulation, the Short-Sighted Ramsey Equilibrium (SSRE), are examined in a differentiated duopoly model. In the optimum, the markup of competitive substitute goods is relatively high. In the SSRE, the regulator is likely to set the price of competitive substitute goods lower than optimal, and complementary goods higher than optimal. Strategic reactions by a competitor may reverse the result.I thank Kenneth Train, Michael Crew (the editor), seminar participants at the University of California, Berkeley, and an anonymous referee for comments and suggestions. The usual disclaimer applies.     

Price rigidities and institutional variations in markets with posted prices

Summary An exchange economy with price rigidities and rationing is considered. The rationing systems allowed are very general. Several characterizations of the set of constrained equilibria are given, and new equilibrium existence results are provided. More specifically, well-known properties like the existence of equilibria without rationing of the numeraire commodity, and the existence of supply and demand constrained equilibria without rationing on the market of at least one commodity follow as special cases from the theorems proved. Finally it is shown that the equilibrium correspondence is upper semi-continuous, while it is continuous on a residual set of points. In order to prove these results a new continuity result for the budget correspondence is given.The author would like to thank Dolf Talman, Gerard van der Laan, Jan van Geldrop, and an anonymous referee for their valuable comments on previous drafts of this paper. The author is financially supported by the Cooperation Centre Tilburg and Eindhoven Universities, The Netherlands. This research is part of the VF-program Competition and Cooperation.     

Individual Decision Making in a Negative Externality Experiment

The experimental treatments analysed in this paper are simple in that there is a unique Nash equilibrium resulting in each player having a dominant strategy. However, the data show quite clearly that subjects do not always choose this strategy. In fact, when this dominant strategy is not a focal outcome it does not even describe the average decision adequately. It is shown that average individual decisions are best described by a decision error model based on a censored distribution as opposed to the truncated regression model which is typically used in similar studies. Moreover it is shown that in the treatments where the dominant strategy is not focal dynamics are important with average subject decisions initially corresponding to the focal outcome and then adjusting towards the Nash prediction. Overall, 66.7% of subjects are consistent with Payoff Maximization, 27.8% are consistent with an alternate preference maximization and 5.6% are random.     

Regulatory hindsight review and innovation by electric utilities

Regulation is often thought to discourage innovation. This problem is not evidenced by electric utility behavior up through the mid-1970s, during which time utilities adopted various new generation technologies. However, retrospective prudence reviews, common since the 1980s, may discourage utilities from investing in promising but risky new technologies. When innovative technologies have lower expected costs but greater cost variance than conventional technologies, the threat of hindsight review may cause a utility to switch from an innovative technology to a more costly conventional one, and may cause underinvestment. Profit-sharing schemes, properly designed, can promote efficient levels of investment in innovative technologies.This paper has benefited from the comments of Kenneth Costello, Tom Grahame, Lorna Greening, Mohammad Harunuzzaman, Douglas Jones, two anonymous referees, and seminar participants at the 1994 meetings of the Transportation and Public Utilities Group of the American Economic Association. Financial support from the U.S. Department of Energy is gratefully acknowledged; the views presented herein, however, are solely those of the author.     

Monetary policy and price level determinacy in a cash-in-advance economy

Summary The paper considers the determinacy of the equilibrium price level in the cash-in-advance monetary economy of Lucas and Stokey (1983, 1987), in the case of deterministic fundamentals. The possibilities both of a multiplicity of perfect foresight equilibria and of sunspot equilibria are considered. Two types of monetary policy regimes are considered and compared, one in which the money supply grows at a given exogenous rate (that may be positive or negative), and one in which the nominal interest rate on one-period government debt is pegged at a given non-negative level. In the case of constant money growth rate regimes, it is shown that one can easily have both indeterminacy of perfect foresight equilibrium and existence of sunspot equilibria; indeed, in the case of negative rates of money growth (as called for by Friedman (1969)), both types of indeterminacy necessarily occur. On the other hand, sufficient conditions for uniqueness of equilibrium (and non-existence of equilibria other than a deterministic steady state) are also given, and a class of cases is identified in which a sufficiently high rate of money growth guarantees this. Thus there may be a conflict between the aims of choosing a rate of money growth that results in a high level of welfare in the steady state equilibrium and choosing a rate that makes this steady state the unique equilibrium.) In the case of the interest rate pegging regimes, sufficient conditions are given for uniqueness of equilibrium (and impossibility of sunspot equilibria), and it is shown that these necessarily hold in the case of any low enough nominal interest rate. Thus the nominal interest rate peg allows simultaneous achievement of price level determinacy and a high level of welfare in the unique (steady state) equilibrium.In this paper I consider the consequences of alternative choices of the monetary policy regime for the determinacy of the rational expectations equilibrium value of money, and in particular for the existence or not of sunspot equilibria, i.e., rational expectations equilibria in which fluctuations in the price level occur in response to random events that represent no change in economic fundamentals, simply due to self-fulfilling revisions of people's expectations. I am interested in particular in making the point that a consideration of the complete set of possible equilibria associated with a given policy regime may alter one's evaluation of the relative desirability of alternative policies, relative to the conclusion that one might reach if one considered only a single possible equilibrium associated with each policy regime (perhaps a unique equilibrium involving a minimum set of state variables). In view of this I give particular attention to policy regimes of types that have sometimes been advocated as ways of reducing the inefficiency associated with a rate of return differential between money and other financial assets, and show that policies that might otherwise be desirable (policies that make possible a more desirable equilibrium than would otherwise be possible) can have the unfortunate consequence of rendering equilibrium indeterminate and making possible equilibrium fluctuations in response to sunspot events.Two classes of policy regimes are considered in particular: on the one hand, alternative constant rates of growth or contraction of the money supply, financed through lump sum taxes or transfers, with zero net government assets at all times; and on the other, alternative constant nominal interest rate pegs, to be maintained through open market operations between money and interest-bearing debt, with an exogenously fixed level of net transfer payments. The first class of policies is considered because of Friedman's (1969) well-known proposal that a constant contraction of the money supply of this sort would be welfare improving. I find that while thestationary equilibrium associated with the Friedman regime achieves the maximum possible level of utility for the representative consumer, and while the level of utility associated with stationary equilibrium may be monotonically decreasing in the rate of money growth, lower rates of money growth (in particular, rates near that called for by Friedman) are associated with indeterminacy of equilibrium and the existence of sunspot equilibria, while these problems need not arise in the case of higher rates of money growth.The second class of policies is considered because they represent an obvious alternative approach to the elimination of the same rate of return differential with which Friedman is concerned. Achievement of permanently low nominal interest rates through a simple interest rate peg is not often advocated; one reason is that it is often asserted that such a policy must result in price level indeterminacy. In fact, I find that if the interest rate pegging regime is properly specified, it results in aunique rational expectations equilibrium, regardless of the level at which interest rates are to be pegged. Thus not only does the interest rate peg not result in price level indeterminacy but it allows nominal interest rates to be maintained permanently at a level lower than that which can be obtained through a policy regime of the first sort without creating price level indeterminacy. It would hence appear, at least in the case of the kind of economy modeled here, that interest rate pegging is a more reliable way of trying to reduce the inefficiency associated with consumers being forced to economize on liquidity.This paper represents a revision of Woodford (1988). I would like to thank Leonardo Auernheimer, Buz Brock, Willem Buiter, Peter Howitt, Teh-Ming Huo, David Laidler, David Levine, Bennett McCallum, and an anonymous referee for helpful comments, and the National Science Foundation for research support.     

The rationality and efficacy of decisions under uncertainty and the value of an experiment

Summary A decision maker faces a known prior distribution over payoff relevant states. We compare the expected utility of this individual under two scenarios. In the first, the decision maker makes a choice without further information. In the second, the decision maker has access to an experiment before choosing an action. However, the decision maker does not know the true joint distribution over states and messages. The value of the experiment as measured by the difference in the two utility levels can be negative as well as positive. We give a condition which is necessary and sufficient for the experiment to be valuable in our sense, for any decision problem.An earlier version of this paper was circulated under the title Noisy Bayes Updating and the Value of Information. We have gained from the comments of Stephen Coate, John Geanakoplos, Larry Samuelson, Timothy Van Zandt and seminar participants at Harvard Business School, Princeton, Boston University, the international conference on game theory at Stony Brook 1992 and the Winter meeting of the Econometric Society at Anaheim 1993. The first author received support for this project from NSF grant #SES-9308515 and a University of Pennsylvania Research Foundation Grant.     

Qualifications,discrimination, or assimilation? An extended framework for analysing immigrant wage gaps

In this paper, we analyze immigrant wage gaps and propose an extension of the traditional wage decomposition technique, which is a synthesis from two strains of literature on ethnic/immigrant wage differences, namely the assimilation literature and the discrimination literature. We estimate separate wage equations for natives and a number of immigrant groups using panel data sample selection models. Based on the estimations, we find that the immigrant wage gap is caused by a lack of qualifications and incomplete assimilation, and that a large fraction of that gap would disappear if only immigrants could find employment and thus accumulate work experience.First version received: June 2001 / Final version received: October 2003The project has been supported financially by the Danish Research Agency (the FREJA grant) and TSER. Furthermore, the first author received support from the Danish Social Science Research Council (SSF) while this work was undertaken. We are grateful for comments from the editor of Empirical Economics, Bernd Fitzenberger, two anonymous referees, several seminar and conference participants, and for the research assistance done by Thomas H. Jensen.     

Exchange rates and bertrand oligopoly

The impact of exchange-rate changes on industrial prices seems ambiguous. Incomplete and even perverse pass-through has been observed: the import prices in the depreciating country decrease while those in the appreciating country increase. To explain these counterintuitive price reactions we consider a situation of international Bertrand competition: two firms, based in different countries, are selling in both countries simultaneously. The profit-maximizing duopolists set the prices for their products in each of the two markets which are segmented on the demand side. We then study the qualitative effect of an exogenous exchange-rate change on the Bertrand-Nash equilibrium. Under the strong assumption of linear demand and cost functions we have normal exchange-rate pass-through. However, allowing for more general cost structures in this simple static model enables us to show that the import prices in both countries might move in counterintuitive directions.     

On multiple equilibria and the rational expectations hypothesis

Summary This paper analyzes through a simple two-period model the fact that, if some agents hold inside money intertemporally, the second-period normalization matters. Thus, there are several equilibria of the second-period economy, indexed by the level of inflation. A concept of equilibrium acknowledging this fact, and requiring that agents put some weight on any of the possible second-period equilibrium price vectors is developed. Such an equilibrium is shown to exist, and is illustrated by an example.This a revised version of chapter three of my Ph.D. dissertation. I would like to thank David Cass, Atsushi Kajii, George Mailath and Shinichi Suda for helpful discussions and comments. Thanks are also due to Jean-Michel Grandmont who pointed out mistakes in a previous version. All remaining mistakes are of course my own. Financial support from a CARESS scholarship at the University of Pennsylvania is gratefully acknowledged.