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.     

Price competition in a differentiated products duopoly under network effects

We examine price competition under product-specific network effects, in a duopoly where the products are differentiated both horizontally and vertically. We emphasize the role of consumers’ expectations formation. When expectations are not influenced by prices, the market may be shared but shares must be equal unless product qualities differ or one firm, possibly even the low-quality one, may capture the entire market. When expectations are influenced by prices, which would be the case when there is commitment, competition becomes more intense and the high-quality firm tends to capture a larger market share. Under strong network effects there is a continuum of equilibria and the higher the prices, the smaller the difference between those prices can be. Requiring continuity of expectations, however, delivers a unique equilibrium where one firm captures the entire market.     

Learning and Noisy Equilibrium Behavior in an Experimental Study of Imperfect Price Competition*

We consider a duopoly pricing game with a unique Bertrand–Nashequilibrium. The high‐price firm has a nonvanishing market share, however, and intuition suggests that observed prices may be positively related to this market share. This relationship is implied by a model in which players make noisy (logit) best responses to expected payoff differences. The resulting logit equilibrium model was used to design an experiment in which the high‐price firm's market share varies. The model accurately predicts the final‐period price averages. A naive learning model predicts the observed differences in the time paths of average prices.     

Price Competition and Product Differentiation When Consumers Care for the Environment

Increasing environmental awareness may affect the pleasure of consuming a good for which an environment friendly substitute is available. In this paper, we investigate the market implication of product differentiation when customers are concerned about environmental aspects of the good. We use the spatial duopoly model to determine how environmental concern affects prices, product characteristics and market shares of the competing firms. Our analysis is based on a two-stage game, where at the first stage each firm chooses the characteristic of its product. At the second stage, each firm chooses its price. Equilibrium prices and market shares are affected by consumer awareness of the environment and by the higher costs for producing those goods. As for the Nash equilibria in the characteristics, we find three equilibria depending on the parameter constellation. In order to find out whether the market functions in an optimal way, we determine the choice of environmental characteristics by a welfare maximizing authority. The objective of the paper is to understand the environmental quality choices facing firms and to provide policies that would align private choices with the social optimum.JEL classifications: L11, Q38, H23     

Public Sector Rationing and Private Sector Selection

We study the interaction between nonprice public rationing and prices in the private market. Under a limited budget, the public supplier uses a rationing policy. A private firm may supply the good to those consumers who are rationed by the public system. Consumers have different amounts of wealth, and costs of providing the good to them vary. We consider two regimes. First, the public supplier observes consumers’ wealth information; second, the public supplier observes both wealth and cost information. The public supplier chooses a rationing policy, and, simultaneously, the private firm, observing only cost but not wealth information, chooses a pricing policy. In the first regime, there is a continuum of equilibria. The Pareto dominant equilibrium is a means‐test equilibrium: poor consumers are supplied while rich consumers are rationed. Prices in the private market increase with the budget. In the second regime, there is a unique equilibrium. This exhibits a cost‐effectiveness rationing rule; consumers are supplied if and only if their cost–benefit ratios are low. Prices in the private market do not change with the budget. Equilibrium consumer utility is higher in the cost‐effectiveness equilibrium than the means‐test equilibrium.     

A laboratory study of advertising and price competition

We use a laboratory experiment to study advertising and pricing behavior in a market where consumers differ in price sensitivity. Equilibrium in this market entails variation in the number of firms advertising and price dispersion in advertised prices. We vary the cost to advertise as well as varying the number of competing firms. Theory predicts that advertising costs act as a facilitating device: higher costs increase firm profits at the expense of consumers. We find that higher advertising costs decrease demand for advertising and raise advertised prices, as predicted. Further, this comes at the expense of consumers. However, advertising strategies are more aggressive than theory predicts with the result that firm profits do not increase.     

Market structure in congestible markets

This paper analyses market structure of industries that are subject to both positive and negative network effects. The size of a firm determines the quality of its product: when network effects are positive, a larger firm is of higher quality; when the effects are negative, a larger firm's product is of lower quality. Consumers have heterogeneous preferences towards quality (firm size), and firms compete in prices. Equilibria are characterised: for example, in any asymmetric equilibrium, it must be that congestion is not too severe. One consequence of this feature is that an increase in the number of firms in the industry can raise individual firms’ profits. Two factors can bound the number of firms in a free-entry equilibrium without fixed costs: expectations, and the ‘finiteness’ property (Shaked and Sutton, Review of Economic Studies 49 (1982) 3–13, Econometrica 51(5) (1983) 1469–1483) of price competition.     

Evaluating wind-following and ecosystem services for hydroelectric dams in PJM

Hydropower can provide inexpensive, flexible fill-in power to compensate for intermittent renewable generation. Policies for hydropower dams maintain multiple services beyond electric generation, including environmental protection, flood control and recreation. We model the decision of a hydroelectric generator to shift some of its power production capacity away from the day-ahead energy market into a “wind-following” service to smooth the intermittent production of wind turbines. Offering such a service imposes both private and social opportunity costs. Since fluctuations in wind energy output are not perfectly correlated with day-ahead energy prices, a wind-following service will necessarily affect generator revenues. Seasonal wind patterns produce conflicts with the goal of managing rivers for “ecosystem services”—the maintenance or enhancement of downstream ecosystems. We illustrate our decision model using the Kerr Dam in PJM’s territory in North Carolina. We simulate the operation of Kerr Dam over a three-year period that features hydrologic variability from normal water years to extreme drought conditions. We use an optimization framework to estimate reservation prices for Kerr Dam offering wind-following services in the PJM market. Wind-following may be profitable for Kerr Dam at low capacity levels during some time periods if ecosystems services are neglected and if side payments, or reserves-type payments, are provided. Wind-following with ecosystem services yields revenue losses that typically cannot be recovered with reserves market payments. Water release patterns are inconsistent with ecosystem-services goals when Kerr Dam dedicates significant capacity to wind-following, particularly in drought years.     

A Model of Spillovers Through Labor Recruitment

This paper develops a model where spillovers can be generated through domestic firm recruitment of employees at a multinational corporation (MNC) where more advanced technologies are employed. It is shown that both spillover and no-spilover equilibria are possible in the model, depending on the marginal costs and benefits of recruitment. Spillover benefits depend on demand parameters and the technological capabilities of the domestic firm, and spillover costs are determined by the MNC's internal wage. Compared with the no-spillover equilibrium, spillovers lead to fewer technology transfers by the MNC and higher market prices. [031, F23]     

Dissertation abstract: Essays on pricing in experimental duopoly markets

This dissertation comprises three independent essays that analyze pricing behavior in experimental duopoly markets. The first essay examines whether the content of buyer information and the timing of its dissemination affects seller market power. We construct laboratory markets with differentiated goods and costly buyer search in which sellers simultaneously post prices. The experiment varies the information on price or product characteristics that buyers learn under different timing assumptions (pre- and post-search), generating four information treatments. Theory predicts that price information lowers the equilibrium price, but information about product characteristics increases the equilibrium price. That is, contrary to simple intuition, presence of informed buyers may impart a negative externality on other uninformed buyers. The data support the model's negative externality result when sellers face a large number of robot buyers that are programmed to search optimally. Observed prices conform to the model's comparative statics and are broadly consistent with predicted levels. With human buyers, however, excessive search instigates increased price competition and sellers post prices that are significantly lower than predicted. The second essay uses experimental methods to demonstrate the anti-competitive potential of price-matching guarantees in both symmetric and asymmetric cost duopolies. When costs are symmetric, price-matching guarantees increase the posted prices to the collusive level. With asymmetric costs, guaranteed prices remain high relative to prices without the use of guarantees, but the overall ability of guarantees to act as a collusion facilitating device depends on the relative cost difference. Fewer guarantees, combined with lower average prices, suggest that cost asymmetries may discourage collusion. The third essay investigates the effect of firm size asymmetry on the emergence of price leadership in a homogeneous good duopoly. With discounting, the unique subgame-perfect equilibrium predicts that the large firm will emerge as the endogenous price leader. Independent of the level of size asymmetry, the laboratory data indicates that price leadership by the large firm is one of the most frequently observed timings of price announcement. In most cases, however, it comes second to simultaneous price-setting. This tendency to wait for the other firm to announce its price is especially strong when the level of size asymmetry between firms is low. We attribute the lower than expected frequency of price leadership to coordination failure, which is further compounded by elements of inequity aversion. JEL Classification C91, D43, D83, L11 Dissertation Committee: Timothy Cason (Chair), Department of Economics, Purdue University Dan Kovenock, Department of Economics, Purdue University Stephen Martin, Department of Economics, Purdue University Marco Casari, Department of Economics, Purdue University     

Controling tax evasion under direct and indirect taxation: Some notes

The purpose of the paper is to use a simple model of the firm having monopoly power in the goods market as the framework to study the relative effectiveness of unit, ad valorem and profit taxes under two alternative criteria when the taxes are changeds so as to keep either the expected utility of the monopoly firm or the expected tax revenues for government constant. Under the former policy the profit tax turns out to be best and the unit tax worst in all respects; for instance, the profit tax will give rise to higher production, lower prices, lower tax evasion and higher tax revenues for government than other taxes. The dominance of the profit tax and the inferiority of the unit tax still holds under the policy of keeping the expected tax revenues constant in terms of production, prices and the expected utility of the monopoly firm. But strikingly, in terms of effectiveness of tax evasion control the ranking of taxes is now exactly the reverse from the one obtained under the expected utility criterium; now the unit tax is best and the profit tax worst.     

Long-term industrial equilibrium in an ITQ managed fishery

This paper discusses long-term equilibrium in a fishery managed by individual transferable quotas. Rising prices or falling capital costs become capitalized in a higher value of quotas, implying higher capital costs for holding quotas. This may in fact reduce the size of each firm and lead to more firms existing in long-term equilibrium. Resource rent taxation by letting firms lose a certain share of their quota holdings each year is discussed and shown to be neutral.     

Can a decline in search cost increase prices?

This paper provides a new explanation of why a decline in consumers’ price search cost may not lead to lower prices. In a duopoly with price competition, I show that when some consumers are captive to one firm, there may be a non‐monotonic relationship between search cost and market power; firms may charge high prices with higher probability and the average price charged may be higher when consumers’ price search cost falls below a critical level. Furthermore, when firms have asymmetric captive segments, expected prices charged by each firm may move in opposite directions as search cost declines.     

INTERNATIONALIZATION STRATEGIES IN OLIGOPOLY WITH HETEROGENEOUS FIRMS

This paper examines the foreign direct investment (FDI) versus exports decision of foreign oligopolistic firms under cost heterogeneity. An additional motivation for firms to invest abroad is the technological sourcing via spillovers, which flow from the host more efficient firm to foreign less advantaged firms. For intermediate values of the set‐up costs associated with FDI entry, it is shown that foreign firms choose opposite entry strategies. An equilibrium where the less efficient foreign firm exports whereas the more efficient invests is more likely to happen when foreign firms become more heterogeneous, the larger the trade costs and not too big oligopolistic profitability. Interestingly, the opposite may also be an equilibrium thus finding that the more efficient firm does not choose to invest, a result that emphasizes the relevance of the strategic setting under consideration. The latter result identifies a market failure since welfare in the host market is higher when both firms undertake FDI; a finding that calls attention to how appropriate are host government policies towards internationalization strategies.     

Price leadership and firm size asymmetry: an experimental analysis

We use laboratory experiments to examine the effect of firm size asymmetry on the emergence of price leadership in a price-setting duopoly with capacity constraints. Independent of the level of size asymmetry, the unique subgame perfect equilibrium of our timing game predicts that the large firm is the price leader. Experimental data show that price leadership by the large firm is frequent, but simultaneous moves are also often observed. Profit outcomes in the previous period affect the subjects’ decisions to announce or wait in a way that hampers convergence to the equilibrium. Furthermore, while both small and large firms display a strong tendency to wait to announce their price when firm size asymmetry is low, they often set prices early when size asymmetry is high. Prices are higher when price setting is sequential rather than simultaneous and when firm size asymmetry is high. Hence, price leadership by either type of firm has an anti-competitive effect that is more pronounced when the size difference between firms is large.     

Influence of market-level and inter-firm differences in costs on product positioning and pricing

The objective of this article is to study the impact of differentiation and firm positioning on firm’s pricing decisions in a horizontally differentiated competitive market. We build a parsimonious game-theoretic model and analyse simultaneous entry of firms. The effect of differentiation is modelled as an additional cost incurred by both firms based on the degree of differentiation between the firms. The cost of positioning is modelled as a market level cost affecting both firms whereby firms incur a cost if they want to position themselves away from the centre of distribution of consumers. Our analysis provides some surprising results, explains some conflicting empirical observations documented in previous research and may also be useful for further empirical research in this area by providing sharper predictions about the impact of various types of costs on market outcomes. For example, we find that if the cost of positioning is sufficiently high, then a firm with lower cost of differentiation charges a higher price in equilibrium, even when no differences in exogenous costs exist. We also find that under some circumstances the cost disadvantaged firm can enjoy higher price-cost margins compared to the cost leader thereby suggesting that higher costs could be a blessing in disguise.     

Pricing to Firm: an Analysis of Firm‐ and Product‐level Import Prices*

We use Hungarian Customs data on product‐level imports of manufacturing firms to document that the import price of a particular product varies substantially across buying firms. We relate the level of import prices to firm characteristics such as size, foreign ownership, and market power. We develop a theory of “pricing to firm” (PTF), where markups depend on the technology and competitive environment of the buyer. The predictions of the model are confirmed by the data: import prices are higher for firms with greater market power, and for more essential intermediate inputs (with a high share in material costs). We take account of the endogeneity of the buyer’s market power with respect to higher import prices and unobserved cost heterogeneity within product categories. The magnitude of PTF is big: the standard deviation of price predicted by PTF is 21.5%.     

声誉、搜寻成本与网上交易市场均衡

本文在搜寻理论的框架内分析了在卖家声誉存在差异的情况下,网上拍卖市场搜寻成本对价格水平和价格离差的影响,进而考察了搜寻成本对网上市场声誉机制的影响。本文的结论是:尽管搜索工具提高了网上交易市场的效率,但网上交易市场仍存在不可忽视的搜寻成本;较高的搜寻成本导致不同声誉水平的卖家同时存在于网上交易市场,高声誉卖家制定的价格较高,低声誉卖家制定的价格较低;搜寻效率的提高可以降低均衡价格水平,网站提供的推广服务也可以降低搜寻成本,降低均衡价格水平。模型很好地解释了网上拍卖市场中的一些现象,也与最近文献的经验事实有较好的吻合。     

The use of data envelopment analysis for the detection of price above the competitive level

Economic theory can predict the impact of exogenous influences on the equilibrium prices in a market. However, it is difficult to measure the magnitude of such effects because the appropriate data are usually not available. In this paper a new approach to comparing prices is explored using individual firm data which are typically available. If the firms in different markets can be assumed to use the same technology, price differentials can be inferred from the estimates can be assumed to use the same technology, price differentials can be inferred from the estimates of best practice frontiers. The new approach is applied to data on the Swiss construction industry in different cantons. In some cantons the market can be said to be competitive, in others non-competitive procurement rules are expected to raise equilibrium prices. The data envelopment analysis estimates the price differential to be approximately equal to 7.5%.Helpful criticism from participants of a seminar at the Business Institute of the University of Vienna are gratefully acknowledged.     

Welfare, home market effects, and horizontal foreign direct investment

Abstract.  We investigate the spatial distribution and organization of an imperfectly competitive industry when firms may choose to operate more than a single production unit. Focusing on a short-run setting with a fixed mass of firms, we first fully characterize the spatial equilibria analytically. Comparing the equilibrium and the first-best, we secondly show that both organizational and spatial inefficiencies may arise. In particular, when fixed costs are low, when transport costs are high, and when products are close substitutes, the market outcome may well have to too many multinationals operating from a social point of view ('over-investment'). As a by-product, under-agglomeration of exporters in the larger market may arise.