Capacity expansion and dynamic monopoly pricing

We substitute to the plant size problem, as investigated by Chenery [Chenery, H., 1952. Overcapacity and the acceleration principle. Econometrica], a new version in which a profit-maximizing monopolist may combine its investment policy with a price policy adjusting demand upwards or downwards over time. We characterize the optimal price and investment policies. The optimal price policy determines an investment pattern either with constant increments of capacity over time, or becoming constant after a finite time. The existing capacity is either fully used at each instant between two investment dates; or the monopolist first quotes the instantaneous monopoly price and, thereafter, the price dampening instantaneous demand at the optimal installed capacity level.     

Regulation of network infrastructure investments: an experimental evaluation

This paper reports the results of an experiment evaluating three regulatory schemes for network infrastructure, in terms of their ability to generate efficient levels of capacity investment. We compare the performance of (1) price cap regulation, (2) a regulatory holiday for new capacity, and (3) price cap regulation with long term contracts combined with a secondary market. The setting is one in which network users can benefit from acting strategically, and are better informed than the network operator about demand growth. We find that the regulatory holiday creates an incentive to underinvest relative to optimal levels. Long term contracts also fail to improve on single price-cap regulation, and may reduce investment by providing noisier signals about future demand.     

Optimal Pricing and Price-Cap Regulation in the Postal Sector

This paper studies the optimal price structure in the postal sector when worksharing is available (e.g., for collection, sorting and transportation) and when the operator faces a break-even constraint. Users differ in opportunity and cost to engage in worksharing. We determine the optimal worksharing discount and provide sufficient conditions (on demand functions) under which it exceeds the ECPR level. Furthermore, we show that the optimal prices can be implemented through a global price cap imposed on a weighted average of the prices of all products. The appropriate weights are proportional to the market demand (evaluated at optimal prices) of the corresponding products.     

Testing for asymmetries in the preferences of the euro-area monetary policymaker

This article tests for asymmetries in the preferences of the euro-area monetary policymaker with 1995:1–2005:2 data from the latest update of the European Central Bank's (ECB's) Area-wide database. Following the relevant literature, we distinguish between three types of asymmetry: precautionary demand for expansions, precautionary demand for price stability and interest rate smoothing asymmetry. Based on the joint generalized method of moments (GMM) estimation of the Euler equation of optimal policy and the aggregate supply-aggregate demand (AS-AD) structure of the macroeconomy, we find evidence of precautionary demand for price stability in the preferences revealed by the monetary policymaker. This type of asymmetry is consistent with the ECB's definition of price stability and with the priority of credibility-building by a recently created monetary authority.     

Advance-purchase discounts as a price discrimination device

In an intertemporal setting in which individual uncertainty is resolved over time, advance-purchase discounts can serve to price discriminate between consumers with different expected valuations for the product. Consumers with a high expected valuation purchase the product before learning their actual valuation at the offered advance-purchase discount; consumers with a low expected valuation will wait and purchase the good at the regular price only in the event where their realized valuation is high. We characterize the profit-maximizing pricing strategy of the monopolist. Furthermore, adopting a mechanism design perspective, we provide a necessary and sufficient condition under which advance-purchase discounts implement the monopolist's optimal mechanism.     

Semicollusion vs. Full Collusion: The Role of Demand Uncertainty and Product Substitutability

We examine the profitability of two different cartel organizational forms: full collusion, under which firms collude on both price and quality, and semicollusion, under which firms collude on price only. We show that, in the presence of demand uncertainty that cannot be contracted upon in the cartel agreement, firms may be better off limiting their collusive agreement to price only. However, a positive relationship between demand uncertainty and the relative profitability of semicollusion exists only for low levels of demand substitutability. The converse is true for high levels of demand substitutability. Therefore, if demand substitutability is sufficiently high, no level of demand uncertainty will make semicollusion the optimal organizational form. In contrast, semicollusion is guaranteed to be optimal for a sufficiently low level of demand substitutability. The market structure described is motivated by and closely parallels that of shipping cartels. Received September 29, 2000; revised version received December 10, 2001 Published online: November 11, 2002     

The analytics of search with posted prices

Summary. This paper investigates the characteristics of the optimal posted price in the standard sequential search paradigm. Much of the intuition gleaned from the extensive sequential search literature in which the seller adopts a reservation price does not carry over to the posted price setting. For example, an increase in buyer valuations can lead to a reduction in the optimal posted price. We do, however, provide sufficient conditions on the hazard rate function h which ensure that an increase in demand induces an increase in the optimal posted price. As exhibited herein, the analysis of the posted price model depends critically upon analytical properties of h. Amongst the issues treated are the elasticity of demand, finite horizon, sale of multiple units, and competitive equilibrium. Received: October 21, 1999; revised version: March 7, 2000     

Profit Maximizing in Auctions of Public Goods

A profit-maximizing auctioneer can provide a public good to a group of agents. Each group member has a private value for the good being provided to the group. We investigate an auction mechanism where the auctioneer provides the good to the group only if the sum of their bids exceeds a reserve price declared previously by the auctioneer. For the two-bidder case with private values drawn from a uniform distribution we characterize the continuously differentiable symmetric equilibrium bidding functions for the agents, and we find the optimal reserve price for the auctioneer when such functions are used by the bidders. We also examine another interesting family of equilibrium bidding functions for this case, with a discrete number of possible bids, and show the relation (in the limit) to the differentiable bidding functions.     

Pro‐Consumer Price Ceilings under Regulatory Uncertainty*

We examine optimal price ceilings when the regulator is uncertain about demand and maximizes expected consumer surplus. With perfect competition, if regulatory uncertainty is large enough, then softer intervention is called for, with the price ceiling set at a relatively high level compared with a full information scenario. In an imperfectly competitive setting where symmetric firms compete in supply functions, with large enough uncertainty, the optimal ceiling increases with the degree of competition, so greater competitive pressure justifies less restrictive regulation. Under perfect competition, we also determine a cut‐off level of rationing efficiency below which a price ceiling should not be used.     

Mixed linear-nonlinear pricing with bundling

The practice of setting marginal prices below marginal costs is so common in telecommunications offerings that it can justifiably be labeled a stylized fact. In this paper, we present a stylized model that establishes conditions under which this practice is economically efficient and profit-maximizing. A multiproduct monopolist who sells some of his goods according to a nonlinear price schedule, while selling the remaining goods at linear prices, is said to use a mixed price structure. We develop a simple model to characterize welfare- and profit-maximizing mixed prices. It is shown that standard results obtained separately for linear and nonlinear prices do not hold when mixed prices are used. In particular, the marginal price facing the largest buyer can be above or below marginal cost. The result is shown to depend on whether the goods are substitutes or complements. Implications of these results for telecommunications prices are derived, and the intuition underlying our stylized fact is developed.     

Disutility and constrained quality choice in self-selection problems

This paper analyzes the self-selection problem in a monopoly market where (i) consumer types are characterized by both utility of service and disutility of interrupted service and (ii) qualities (reliabilities) are interdependent. We derive behavior of a profit-maximizing monopolist in offering self-selection menu of price and reliability and in choosing capacity investment. We further analyze welfare distortions of the monopolistic behavior. The major findings are: (i) depending on the magnitude of utility and disutility, either consumer type may end up with zero surplus, (ii) the possibility of inefficient production may lead to idle capacity, and (iii) depending on the consumer preference structure, the monopolist's investment is lower than, equal to, or higher than the socially optimal level.     

Examining crop price effects on production decision and resource allocation: an ex-ante approach

This article examines the output price effects on the US crop production, employing an ex-ante approach to the differential systems of input demand and output supply. The estimation results of the differential input demand show that the expansion of crop production leads to an increase in acreage (i.e. extensive margin) and a proportional rise in input usage improving yield per acre (i.e. intensive margin). The substitutable relationship between fertilizer and land supports that crop producers have an option to choose either intensive or extensive margin in response to changes in their relative prices. In addition, the estimation results of the differential output supply highlight that the composition of crop supply can be altered by changes in ex-ante crop prices. The estimation results suggest that crop producers substitute corn supply for the supply of cotton, wheat and soybeans or vice versa. Based on the estimated elasticities, the decompositions of profit-maximizing input demand are conducted, which reveals that a change in ex-ante crop prices is associated closely with resource reallocation.     

Corporate social responsibility and marketing channel coordination

We analyze a simple linear demand bilateral monopoly situation where one of the firms, either the up-stream manufacturer or the down-stream retailer, is socially concerned in terms of its desire to enhance its end-customers’ welfare in addition to the traditional profit motive. Two cases are explored: the up-stream producer exhibits corporate social responsibility (CSR) in one case and the down-stream retailer in the other. In the two-stage game, the retailer makes their quantity-setting decision in stage-two, given the two-part tariff (wholesale price and fixed franchise fee) set by the stage-one producer. In this setting, among other things, we find that the optimal channel-coordinating tariff is very different from the standard pure profit-maximizing two-part tariff. For example, if either firm in the supply/marketing chain exhibits CSR, we show the optimal wholesale price does not equal the manufacturer’s marginal production cost, nor does the fixed fee equal the monopoly profit earned by the retailer. Finally, we find that our two-part tariff CSR model provides a theoretical rationale for the empirical finding of little to no correlation between CSR and firm profits.     

Persistent media bias

The news media plays an essential role in society, but surveys indicate that the public views the media as biased. This paper presents a theory of media bias that originates with private information obtained by journalists through their investigations and persists despite profit-maximizing news organizations and rivalry from other news organizations. Bias has two effects on the demand for news. First, rational individuals are more skeptical of potentially biased news and thus rely less on it in their decision-making. This skepticism reduces demand and leads the news organization to set a lower price for its publication the greater is the bias it tolerates. Lower quality news thus commands a lower price. Second, bias makes certain stories more likely than others. Given their private information, journalists may bias their stories if their career prospects can be advanced by being published on the front page. News organizations can control bias by restricting the discretion allowed to journalists, but granting discretion and tolerating bias can increase profits if it allows journalists to be hired at a lower wage. Bias is not driven from the market by a rival news organization nor by a news organization with an opposing bias, and the profits of a high-bias news organization can be higher than the profits of a low bias one. Moreover, bias can be greater with competition than with a monopoly news organization. If individuals collectively choose regulation in place of their individual decision-making, bias increases the expected stringency of regulation.     

The market power of OPEC 1973–2001

We apply a multi-equation dynamic econometric model on monthly data to test if the behaviour of OPEC as a whole or different sub-groups of the cartel is consistent with the characteristics of dominant producers on the world crude oil market in the period 1973–2001. Our results indicate that the producers outside OPEC can be described as competitive producers, taking the oil price as given and maximizing profits. The OPEC members do not fit the behaviour of price-taking producers. Our findings of low residual demand price elasticities for OPEC underpin the potential market power of the producer group, and are in line with the results in some recent energy studies. On the other hand, our findings indicate that neither OPEC nor different sub-groups of the cartel can be characterized as a dominant producer in the period 1973–1994. However, we find that the characteristics of a dominant producer to some extent fit OPEC-Core as from 1994. Thus, although OPEC clearly has affected the market price, the producer group has not behaved as a pure profit-maximizing dominant producer.     

Loss aversion and market crashes

This study proposes a rational expectation equilibrium model of stock market crashes with information asymmetry and loss averse speculators. We obtain a state-dependent linear optimal trading strategy, which makes the equilibrium price tractable. The model predicts nonlinear market depth and the result that small shocks to fundamentals (e.g., supply or informational shocks) can cause abrupt price movements. We demonstrate that short-sale constraints intensify asset price collapses relative to upward movements. The model also generates contagion between uncorrelated assets. These results are consistent with the main puzzling features observed during market crashes, namely abrupt and asymmetric price movements that are not driven by major news events but coupled with a spillover effect between unrelated markets.     

Collusion and Price Rigidity

We consider an infinitely repeated Bertrand game, in which prices are publicly observed and each firm receives a privately observed, i.i.d. cost shock in each period. We focus on symmetric perfect public equilibria, wherein any "punishments" are borne equally by all firms. We identify a tradeoff that is associated with collusive pricing schemes in which the price to be charged by each firm is strictly increasing in its cost level: such "fully sorting" schemes offer efficiency benefits, as they ensure that the lowest-cost firm makes the current sale, but they also imply an informational cost (distorted pricing and/or equilibrium-path price wars), since a higher-cost firm must be deterred from mimicking a lower-cost firm by charging a lower price. A rigid-pricing scheme, where a firm's collusive price is independent of its current cost position, sacrifices efficiency benefits but also diminishes the informational cost. For a wide range of settings, the optimal symmetric collusive scheme requires (i) the absence of equilibrium-path price wars and (ii) a rigid price. If firms are sufficiently impatient, however, the rigid-pricing scheme cannot be enforced, and the collusive price of lower-cost firms may be distorted downward in order to diminish the incentive to cheat. When the model is modified to include i.i.d. public demand shocks, the downward pricing distortion that accompanies a firm's lower-cost realization may occur only when current demand is high.     

ASYMMETRIC INFORMATION FLOWS IN CUSTOMER MARKETS

In customer markets an information asymmetry exists between a firm's current customers and prospective customers. When a firm changes its price, current customers are instantly aware of the price change, while potential customers are informed slowly of the change. The paper explicitly models this information imperfection and the associated asymmetry in firms' customer flows. The main result of the paper is that, because of the information asymmetry, there will be a range of marginal cost and demand over which the firm has no incentive to change price. It is also shown that prices will be more upwardly flexible than downwardly flexible. The size of the range, and the extent of downward price inflexibility, depends on the rate at which information is transmitted to customers.     

Luddites, the industrial revolution, and the demographic transition

Technological change was unskilled-labor-biased during the early industrial revolution, but is skill-biased today. This implies a rich set of non-monotonic macroeconomic dynamics which are not embedded in extant unified growth models. We present historical evidence and develop a model which can endogenously account for these facts, where factor bias reflects profit-maximizing decisions by innovators. In a setup with directed technological change, and fixed as well as variable costs of education, initial endowments dictate that the early industrial revolution be unskilled-labor-biased. Increasing basic knowledge then causes a growth takeoff, an income-led demand for fewer but more educated children, and a transition to skill-biased technological change in the long run.     

Imported inputs and privatization in downstream mixed oligopoly with foreign ownership

This paper examines welfare implications of privatization in a mixed oligopoly with vertically related markets, where an upstream foreign monopolist sells an essential input to public and private firms located downstream in the domestic country. The impact on domestic welfare of privatizing the downstream public firm is shown to contain three effects. The first is an output distortion effect, which negatively affects welfare since privatization decreases the production of final good for consumption. The second is an input price lowering effect resulting from a decrease in derived demand for the input. When the level of privatization increases, a decrease in final good production lowers input demand, causing input price to decline and domestic welfare to increase. The third is a rent‐leaking effect associated with foreign ownership in the downstream private firm. The rival domestic firm strategically increases its final good production, causing profits accrued to foreign investors to increase and domestic welfare to decline. Without foreign ownership in the downstream private firm, the optimal policy toward the public firm is complete privatization as the output distortion effect is dominated by the input price lowering effect. With foreign ownership, however, complete privatization can never be socially optimal due to the additional negative impact on domestic welfare of the rent‐leaking effect. We further discuss implications for domestic welfare under different privatization schemes (e.g., selling the privatization shares to the upstream foreign monopolist or to the rival domestic firm).