Prices and Deadweight Loss in Multiproduct Monopoly

The paper investigates prices and deadweight loss in multiproduct monopoly with linear interrelated demand and constant marginal costs. We show that, with commonly used models for linear demand such as the Bowley demand and vertically or horizontally differentiated demand, the price for each good is independent of demand cross‐effects and of the characteristics and number of other goods. This contrasts with the oft‐expressed view that prices critically depend on demand cross‐effects. We also show that for these linear models, the deadweight loss due to monopoly amounts to half the total monopoly profit. Finally, we show how a production subsidy might restore social efficiency.     

The Law of One Price—A Case Study

We use retail transaction prices for a multinational retailer to examine the extent and permanence of violations of the law of one price. For identical products, we find typical deviations of 20–50 percent, with some evidence for convergence over time. Such differences might be due to differences in local costs. If so, relative prices of similar products (round versus square mirrors) should be equal across countries. In fact, relative prices vary significantly across very similar goods within a product group. The finding suggests that differences in local distribution costs, local taxes, and probably tariffs do not explain the price pattern, leaving strategic pricing or other factors resulting in varying markups as alternative explanations.
JEL classification : F 41; L 11     

Measurement and Allocation of Capital Inputs With Taxes: A Sensitivity Analysis for OECD Countries

Taxes affect the measurement of capital inputs. The paper provides an assessment of these impacts in a cross‐country framework where heterogeneity of corporate taxation across industries and asset types is accounted for. The results show that taxes change the relative prices of capital types, which, in turn, has implications on the estimated capital quality and reallocation effects in the traditional growth accounting framework. Omitting tax parameters is a source of mismeasurement, particularly when the rental price of capital assets is constructed using an external rate of return, leading to biased capital costs and profits rates. It is shown that differential taxation results in a deadweight loss in terms of misallocated capital inputs, predominantly due to composition effects within industries.     

Should the Carbon Price Be the Same in All Countries?

International differences in fuel taxation are huge, and may be justified by different local negative externalities that taxes must correct, as well as by different preferences for public spending. In this context, should a worldwide uniform carbon tax be added to these local taxes to correct the global warming externality? We address this question in a second best framework à la Ramsey, where public goods have to be financed through distortionary taxation and the cost of public funds has to be weighted against the utility of public goods. We show that when lump‐sum transfers between countries are allowed for, the second best tax on the polluting good may be decomposed into three parts: one, country‐specific, dealing with the local negative externality, a second one, country‐specific, dealing with the cost of levying public funds, and a third one, global, dealing with the global externality and which can be interpreted as the carbon price. Our main contribution is to show that the uniformity of the carbon price should still hold in this second best framework. Nevertheless, if lump‐sum transfers between governments are impossible to implement, international differentiation of the carbon price is the only way to take care of equity concerns.     

SOME WELFARE IMPLICATIONS OF OPTIMAL STABILISATION POLICY IN AN ECONOMY WITH CAPITAL AND STICKY PRICES

In this paper we review and extend some of the key lessons that seem to be emerging from the Ramsey‐inspired theory of dynamic optimal monetary and fiscal policies. We construct measures of the key distortions in our economy; we label these ‘dynamic wedges’. Inflation, actual or anticipated, distorts these wedges in the present period, shrinks the tax base and increases the deadweight loss. We show that, if possible, labour as well as capital ought to be subsidised in steady state. We point to a number of extensions to the Ramsey literature that may help in the formulation of actual policy.     

Optimal fiscal and monetary policy with sticky wages and sticky prices

We determine the optimal degree of price inflation volatility when nominal wages are sticky and the government uses state-contingent inflation to finance government spending. We address this question in a well-understood Ramsey model of fiscal and monetary policy, in which the benevolent planner has access to labor income taxes, nominally risk-free debt, and money creation. Our main result is that sticky wages alone make price stability optimal in the face of shocks to the government budget, to a degree quantitatively similar as sticky prices alone. Key for our results is an equilibrium restriction between nominal price inflation and nominal wage inflation that holds trivially in a Ramsey model featuring only sticky prices. Our results thus show that when nominal wages are sticky, setting real wages as close as possible to their efficient path is a more important goal of optimal monetary policy than is financing innovations in the government budget via state-contingent inflation. A second important result is that the nominal interest rate can be used to indirectly tax the rents of monopolistic labor suppliers. Taken together, our results uncover features of Ramsey fiscal and monetary policy in the presence of a type of labor market imperfection that is widely-believed to be important.     

Inflation,tax rules,and the prices of land and gold

Traditional theory implies that the relative price of consumer goods and of such real assets as land and gold should not be permanently affected by the rate of inflation. A change in the general rate of inflation should, in equilibrium, cause an equal change in the rate of inflation for each asset price. The experience of the past decade has been very different from the predictions of this theory: the prices of land, gold, and other such stores of value have increased by substantially more than the general price level. The present paper presents a simple theoretical model that explains the positive relation between the rate of inflation and the relative price of such real assets. More specifically, in an economy with an income tax, an increase in the expected rate of inflation causes an immediate increase in the relative price of such ‘store of value’ real assets. The behavior of real asset prices discussed in this paper is thus a further example of the non-neutral response of capital markets to inflation in an economy with income taxes.     

Temporary Bottlenecks,Hydropower and Acquisitions*

We apply a model with four markets, two regions and two time periods, to study the effects of an acquisition in a hydropower system with temporary bottlenecks. The effect on welfare is found to be ambiguous. In some instances an acquisition leads to larger differences in prices between markets, which gives rise to an increase in deadweight loss. In other instances it leads to a reduction in price differences between markets, particularly if the dominant firm acquires a firm which was active in the market where the dominant firm used to dump its production before the acquisition.     

How do firms adjust their prices in Turkey? Micro-level evidence

This article investigates the pricing behaviour of Turkish firms over the period 1988–2006 on the basis of firm-level micro data. The duration of prices is found to be 3.9 months on average. There is no clear heterogeneity across main groupings in the frequency of price changes, but more dependence on imported goods reduces price stickiness. Price decreases are less frequent than price increases, indicating downward rigidity in prices. There is evidence in favour of both time and state-dependent price setting behaviours. Further, there is a low degree of synchronization of price changes across firms, whereas price increases tend to be more synchronized than price decreases. Ordered probit models show that price adjustments depend on the type of the shock: the pass-through of a change in the cost is faster than changing demand. Besides, estimated probabilities of price adjustments with 5-years rolling windows reveal that inflation targeting has succeeded in bringing down the probability of price increases, whereas downward price rigidity has not weakened yet.     

Price Effects on Compound Commodities

We examine the effect of simultaneous price changes on the total demand for a group of goods, which we call a compound commodity. Specifically, we consider unit and proportional cost components (e.g., taxes, transportation costs) imposed on compound commodities. If the unit cost is positive, then the proportional cost raises the relative price of the more expensive good, and thus induces substitution towards the less expensive good within this group. Then, the substitution effect of the proportional cost for a compound commodity is non‐negative if and only if the compound commodity and the other goods are, on average, not strongly substitutable.     

The Behaviour of the Real Exchange Rate: Evidence from an Alternative Price Index

Although the long–run purchasing power parity (PPP) hypothesis is expected to hold across tradable goods, all price indices available to researchers for testing the validity of PPP contain some proportion of non–tradable goods prices, which may generate substantial persistence in the real exchange rate. We construct time series for quarterly price indices that minimize the presence of non–tradable goods for six major economies. Applying recently developed nonlinear econometric techniques to the resulting five US dollar real exchange rate series for the recent floating exchange rate regime, we provide evidence that the nonlinear mean reverting properties of these real exchange rate series are stronger than the mean reverting properties of real exchange rate time series constructed using the consumer price index (CPI). In turn, these results have a natural economic interpretation.
(J.E.L.: F31).     

Optimum commodity taxation in pooling equilibria

This paper extends the standard model of optimum commodity taxation (Ramsey, F., 1927. A Contribution to the Theory of Taxation. Economic Journal 37, 47–61; Diamond, P., Mirrlees, J., 1971. Optimal Taxation and Public Production, II: "Tax Rules". American Economic Review 61, 261–278) to a competitive economy in which markets are inefficient due to asymmetric information. Insurance markets are prime examples: consumers impose varying costs on suppliers but firms cannot associate costs with individual customers and consequently all are charged equal prices. In such a competitive pooling equilibrium, the price of each good is equal to the average of individual marginal costs weighted by equilibrium quantities. We derive modified Ramsey–Boiteux Conditions for optimum taxes in such an economy and show that, in addition to the standard formula, they include first-order effects which reflect the deviations of prices from marginal costs and the response of equilibrium quantities to the taxes levied. An explanation of the additional terms is provided. It is shown that a condition on the monotonicity of demand elasticities enables to sign the direction of the deviations from the standard case.     

Conservation: From Voluntary Restraint to a Voluntary Price Premium

This paper investigates how concern for the environment translates into predictable patterns of consumer behavior. Two types of behavior are considered. First, individuals who care about environmental quality may voluntarily restrain their consumption of goods and services that generate a negative externality. Second, individuals may choose to pay a price premium for goods and services that are more environmentally benign. A theoretical model identifies a symmetry between such voluntary restraint and a voluntary price premium that mirrors the symmetry between environmental policies based on either quantities (quotas) or prices (taxes). We test predictions of the model in an empirical study of household electricity consumption with introduction of a price-premium, green-electricity program. We find evidence of voluntary restraint and its relation to a voluntary price premium. The empirical results are consistent with the theoretical model of voluntary conservation.      

Should Ramsey-price markups differ?

Little adjustment in labor or leisure time is possible because of standardized work weeks in many countries. Without such labor-leisure adjustment, the logic of the inverse-elasticity-rule form of Ramsey price, with its differing percentage markups, is undermined. Moreover, if consumption of a good or service requires a certain amount of the consumer's time, that fact should be an influence on the socially optimal price. These two considerations of consumers' time are shown to warrant serious attention in applications of Ramsey prices.     

Optimal Fiscal Policy in a Multisector Model: The Price Consequences of Government Spending

This paper investigates optimal fiscal policy in a static multisector model. A Ramsey type planner chooses tax rates on each good type as well as spending levels on each good type subject to an exogenous total expenditure constraint. It is shown that, like taxes, government spending policy has price effects and that these price effects have significant implications for optimal policy. These price effects imply a U shape to the government's objective function and this U shape results in boundary values for the choice of the spending allocation. In particular, it is shown that the optimal allocation of government spending tends to be concentrated on one good rather than spread among many goods.     

Home bias, distribution services and determinants of real exchange rates

This paper examines empirically how exogenous changes in the terms of trade affect the real exchange rate through the relative price of traded goods with Canada–US data. The relative price of traded goods is constructed using prices at the dock and retail prices. The first measure emphasizes the importance of home bias in consumption of traded goods. The second measure highlights the importance of distribution services required for consumption of traded goods. It is found that terms of trade shocks affect the relative price of traded goods using both measures. A possible interpretation of empirical findings is that home bias and distribution services are important for understanding the relative price of traded goods.     

Are there bubbles in Chinese RMB–dollar exchange rate? Evidence from generalized sup ADF tests

This article uses recently developed generalized sup ADF (GSADF) unit root tests into the analysis of nominal RMB–dollar exchange rates bubbles. Based on the results from the GSADF tests, we find strong evidence of explosive behaviour in the nominal exchange rate and investigate two bubbles there. The first bubble is during 2005–2006 which is determined neither by the relative prices of traded goods nor the relative price of nontraded goods. The second bubble busts in 2008 during subprime crisis period, and which is determined by the relative prices of traded goods but not the relative price of nontraded goods. There is no bubble before 2005 as the exchange rate is under fixed regime. As for this result, some expansionary monetary and fiscal policies are required in China since these are the most efficient and effective under a bubble burst scenario.     

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.     

Measuring the effectiveness of cost and price competitiveness in external rebalancing of euro area countries: What do alternative HCIs tell us?

This study examines the marginal effects of traditional determinants of exports and imports with a focus on the role of price competitiveness in restoring external balances in the euro area. It is a first attempt to compare marginal effects of various harmonised competitiveness indicators (HCIs) on both exports and imports of both goods and services across individual euro area countries. We find evidence that HCIs based on broader cost and price measures have a larger marginal effect (with some exceptions) on exports of goods. Exports of services are sensitive to HCIs in big euro area countries and Slovakia, where exports of services are also found more sensitive to competitiveness indicators based on broader price measures. Imports of goods and imports of services are quite insensitive to changes in relative prices. Finally, in some cases measures of fit indicate that a large unexplained residual part is present, implying that other non-price related factors might play an important role in driving foreign trade and policies aimed at enhancing the quality of goods traded are warranted.     

The asymmetric impacts of monetary policy on housing prices: A viewpoint of housing price rigidity

Previous studies have discovered the defensive characteristics of housing prices, which is also known as downward price rigidity. This paper discusses whether this feature would result in an asymmetric relationship between housing prices and monetary policy. This paper first uses the loss aversion behavior of traders to assess the viability of housing price rigidity in the housing market and to deduce further that if downward housing price rigidity actually existed, then the impact of monetary policy on housing prices should be asymmetric. For empirical tests, this paper uses data from the UK housing market and then uses the money supply as the proxy variable of monetary policy. The relationships between these two variables are observed. This paper performs estimation using both traditional and threshold error correction models by comparing the coefficients of both models. The results indicate that housing price is indeed asymmetrically adjusted to money supply. When housing prices increase to reflect a loose monetary policy, a modification behavior is evident. Conversely, housing prices cannot easily reflect a tight monetary policy. This result indicates that housing prices tend to overreact in upturn and underreact in downturn. The results imply that when implementing relevant policies for the housing market, the government should consider the asymmetry of housing price changes. Otherwise, the situation can easily result in the creation of a bubble or the collapse of the housing market because of incorrect policies.