Dynamic Model for Market Competition and Price Rigidity

This article presents a price floor model in which durability, unit costs and production period are factors in explaining price rigidity. This article elaborates that cost structure plays an essential role in resolving the inconclusive relationship between market concentration and price rigidity. When the industry is characterized by decreasing returns of scale, the degree of price flexibility decreases as market competition intensifies. The reverse is true when the industry exhibits increasing returns of scale. The factors that cause price rigidity also foster price adjustment asymmetry and price adjustment lag. During times of recession, the model exhibits upward price flexibility as costs increase, but downward price rigidity as costs decrease. Even under forward-looking expectations, the way in which firms adjust prices could look as though they have adaptive expectations. If price stickiness is a characteristic of market competition, then public policies determined by price level could be too drastic for firms in competitive markets.     

Product mix,transactions and cost behaviour: a study of South African bank branches

This paper utilizes microeconomic theory and a panel data set to assess the impact of product mix and transactions on cost behaviour of bank branches in South Africa over the short and long‐term. Estimates of properties of concavity and monotonocity indicate that the cost functions of typical bank branches in South Africa are neither consistent with short‐term nor long‐term cost‐minimizing behaviour. This corroborates earlier findings which indicate that South African banks have low production efficiency and high market power. In addition the cost functions and two production‐output type indices indicate that overall, the intermediation‐output type mix (foreign exchange and custodial services) has a more significant effect on cost behaviour than the production‐output type mix (cheque and deposit accounts). The variety of production‐output type services provided by a branch appears to have limited effect on costs. However the financial value of production‐output type transactions has an impact on costs while the financial value of intermediation type products does not. Branches that provide intermediation‐output type products tend to have higher variable costs – the key determinant of costs is the number of transactions.     

COMPETITIVE LONG RUN INDUSTRY EQUILIBRIUM AND FACTOR-PRICE UNCERTAINTY*

In this paper we have considered competitive long run industry equilibrium with factor-price uncertainty. We discussed the long run equilibrium output of firms with risk neutrality, output price and their responses to changes in uncertainty, factor price and industry demand. In the first part of this paper we have derived a result that, given risk neutrality, the firms operate at proper capacity, i.e. where expected long run marginal cost is equal to expected long run average cost, as shown in the case of output-price uncertainty. This result is, however, different from that obtained from Sheshinski and Dréze (1976). From the comparative static analysis we first discovered that even under risk neutrality factor-price uncertainty affects the long run industry equilibrium: that is, a mean preserving increase in uncertainty leads firm's to enter the industry, because they can decrease expected long run costs as the variability of factor price increases. Consequently, output price goes down. In contrast, firm size is kept invariable in response to its increase as long as the cost function is separable, i.e. the separability of the cost function holds when production functions are the Cobb-Douglas and CES types used commonly in empirical work, although firm size might, generally, be affected by the increase. It is an interesting fact that firm size and industry size will express different responses to a change in risk. The result that the long run industry equilibrium with cost uncertainty is explicitly affected is a sharp contrast to the result under output-price uncertainty and provides a new aspect for understanding about the behaviour of the industry with uncertainty. Secondly, increased factor-price causes the number of firms in the industry to decline and output price to rise. In addition, firm's size will expand with its increase if that factor is inferior, while the effect on firm size is ambiguous if it is normal. The firm's output, i.e. firm size, is, however, kept constant if the cost function is separable. Thirdly, the long run equilibrium output of the firm remains intact but the number of firms increases as industry demand rises. This result holds, regardless of the firm's attitude towards risk. Finally, we find throughout the paper that the functional form of the cost function plays a significant role in determining the behaviour of the industry with factor-price uncertainty.     

South African trade policy mattersTrade performance and trade policy*

South African trade policy has exerted a major influence on the composition and aggregate growth of trade. In the Apartheid period, South Africa developed a comparative advantage in capital‐intensive primary and manufactured commodities partly because of its natural resource endowments, but also because the pattern of protection was particularly detrimental to exports of non‐commodity manufactured goods. By contrast, trade liberalization from 1990 not only increased imports, but by reducing both input costs and the relative profitability of domestic sales also boosted exports. This evidence suggests that additional trade liberalization and policies that afford South African firms access to inputs at world prices could well be part of the strategy to enhance export diversification.     

Unit versus Ad Valorem Taxes in Multiproduct Cournot Oligopoly

The welfare dominance of ad valorem taxes over unit taxes in a single‐market Cournot oligopoly is well known. This article extends the analysis to multimarket oligopoly. Provided all ad valorem taxes are equal and positive, unit costs are constant, firms are active in all considered markets, and a representative consumer has convex preferences, ad valorem taxes are shown to dominate in multiproduct equilibrium. Conditions exist, however, under which economic efficiency declines upon replacing specific taxes with ad valorem taxes that preserve output levels. We discuss the roles of unit cost covariances across multiproduct firms, and also of complementarity in demand, in determining the extent of cost efficiencies arising under ad valorem taxation. For goods that are complementary or independent in demand, conditions are found such that industry profits decline upon use of ad valorem taxes.     

Cost efficiency and scale economies in the Turkish insurance industry

This article examines the cost efficiency and scale economies of insurance firms in the Turkish insurance industry over a 15-year period, 1990–2004. Using the stochastic cost frontier model, cost efficiency scores and scale economies were estimated for each firm in the sample. The results show that mean cost inefficiencies range between 18.3 and 36.9% of total costs and they do not tend to decrease over time. On average, small firms are more cost efficient than large firms. Economies of scale appear present and significant for any class size. The results suggest that there is a substantial difference in scale economies between small and large insurance firms.     

Production and costs in the South African motor vehicle industry

This study investigates the existence of economies of scale in the South African motor vehicle industry as well as the substitution possibilities between input pairs and the direct and cross-price elasticities of demand for the various inputs. Because of data limitations, a translog cost function was estimated for only a three input model corresponding to a homogeneous production function involving capital, labour and intermediate goods. The issue of the existence of economies of scale in the South African motor vehicle industry is a particularly important one because South Africa once again is a member of GATT and a full participant in the international trade arena. The null hypothesis of constant returns to scale was rejected at the 0.5% level of significance. Thus, the results of this model are certainly consistent with economies of scale in the South African motor vehicle industry. The estimated direct price elasticities were consistent with the hypothesis that, during the past two decades, capital was the productive factor with the most elastic demand, and the estimated cross-elasticities between input pairs generally supported the hypothesis that all inputs are substitutes.     

Performance of European insurance firms in the single insurance market

The deregulation and liberalization process towards establishing a single European financial market has some important implications for the insurance industries. Due to the increased competition, insurance firms have to adjust their costs and operate efficiently to survive in this new environment. This paper attempts to analyze the cost efficiency and scale economies in the single European insurance market. Considering the ongoing enlargement process of the EU, our sample includes the insurance industries of the major EU‐15, four new members and a candidate country, Turkey, over the period 1995–2005. We use the firm‐level financial data and estimate a stochastic cost frontier that controls for differences in environmental conditions. All insurance systems display significant levels of cost inefficiency. The results further indicate that there are significant economies of scale, particularly for small‐ and medium‐size insurance firms. Finally, the analyses suggest similar results for major EU countries, new members and the candidate.     

On the development strategy of countries of intermediate size—An analysis of heterogeneous firms in a multi-region framework

This paper compares two policies: trade cost reduction and firm relocation cost reduction using a three-country version of a heterogeneous-firms geography and trade model, where the three countries have different market (population) sizes. We show how the effects of the two policies differ, in particular for the country of intermediate size. Unless the intermediate country is very small, in a relative sense, it will gain industry when relocation costs are reduced, but lose industry when trade costs are reduced. The smallest country loses industry in both cases, but only experiences lower welfare in the case of lower relocation costs. Thus, the ranking of the policies from the point of view of the two small and intermediate countries tends to be the opposite.     

Asymmetric Monotone Comparative Statics for the Industry Compositions

Within a standard model of international trade with heterogenous firms and two asymmetric countries, we derive sufficient conditions for monotone comparative statics (MCS) for the industry composition. This model outcome is defined as first‐order stochastic dominance shifts in the equilibrium distributions of all activities across active firms. MCS for the industry composition occurs in a country that experiences a decline in its costs of serving the foreign market and meanwhile experiences an increase in its level of competition. In the other country, the industry‐level implications are exactly opposite. These clear industry‐level results hold while firms respond asymmetrically to the trade shock.     

Firm selection and industry evolution: the post-entry performance of new firms

A dynamic framework based on the process of firm selection and industry evolution is used to analyse the post-entry performance of new firms. In particular, it is hypothesized that, based on the stylized fact that virtually all new firms start at a very small scale of output, firm growth and survival are shaped by the need to attain an efficient level of output. The post-entry performance of more than 11,000 U.S. manufacturing firms established in 1976 is tracked throughout the subsequent tenyear period. Firm growth is found to be negatively influenced by firm size but positively related to the extent of scale economies, capital intensity, innovative activity, and market growth. By contrast, the likelihood of survival is identified as being positively influenced by firm size, market growth, and capital intensity, but negatively affected by the degree of scale economies in the industry. When viewed through the dynamic framework of firm selection and industry evolution, the empirical results shed considerable light on several paradoxes in the industrial organization literature, such as the continued persistence over time of an asymmetrical firm-size distribution consisting predominantely of suboptimal scale firms, and the failure of capital intensity and scale economies to substantially deter the entry and start-up of new firms.     

Regulating away competition: the effect of regulation on entrepreneurship and employment

Many scholars have worried that regulation deters entrepreneurship because it increases the cost of entry, reduces innovation in the regulated industry, and benefits large firms because they can overcome the costs of complying with regulations more easily than smaller firms. Using novel data on the extent of US federal regulations by industry and data on firm births and employment from the Statistics of US Businesses, we run fixed effects regressions to show that more-regulated industries experienced fewer new firm births and slower employment growth in the period 1998–2011. Large firms may even successfully lobby government officials to increase regulations to raise their smaller rivals’ costs. We also find that regulations inhibit employment growth in all firms and that large firms are less likely to exit a heavily regulated industry than small firms.     

Cost Signals under Uncertain R&D Outcomes

When it is difficult for firms to differentiate their products from those of their competitors, research and development (R&D) spending on process innovation to lower the cost of production is crucial for profitability. However, the information asymmetry in production costs that results from innovation reduces the efficiency of all firms in a market for a homogeneous good. We employ a signalling game to discuss the feasibility of utilising R&D spending and output levels as cost signals in an environment of quantity competition. The results show that a firm does not spend its money on R&D solely to signal the type of cost. Rather, R&D spending may be chosen as a cost signal over the output level only if expenditures on R&D can lead to a sufficiently high probability of reducing production costs.     

Market size and entry in international trade: Product versus firm fixed costs

This paper develops a theoretical framework to infer the nature of fixed costs from the relationship between entry patterns in international markets and destination market size. If fixed costs are at the firm level, firms take advantage of an intrafirm spillover by expanding firm‐level product range (scope). Few firms enter with many products and dominate international trade. If fixed costs are at the product level, an interfirm spillover reduces the fixed costs to export for all firms producing the product. The resulting entry pattern consists of many firms exporting different varieties of the same product. Using cross‐country data on firm and product entry, I find empirical evidence consistent with product‐level costs. More firms than products enter in larger markets offering their consumers lower prices and a greater variety of goods within the product category.     

Exit with incomplete information about cost

This paper presents a model of output decisions by competitive firms which have incomplete information about costs. Unlike other work on this topic, our model incorporates the possibility of exit from the market after a firm has observed its unit cost. At the equilibrium expected aggregate output and the likelihood of exit depend upon the opportunity cost of staying in the market, the number of informed firms, and the intensity of competition. Uninformed firms may be better off than informed firms if exit is feasible. As a result, even if all firms face the same cost of acquiring information, informed firms may coexist with uninformed firms.     

On the Relationship Between Innovation and Product Market Competition

This paper considers a theoretical model where firms reduce their initial unit costs by spending on R&D activities in a collusive market and where firms are able to coordinate on distinct output levels other than that of the unrestricted joint profit maximization outcome. We show that, in our model, the degree of collusion (captured by the discount factor) reduces the incentive to innovate when innovation is made non‐cooperatively. The reason is that non‐cooperative R&D introduces a negative externality where firms overinvest beyond the effort required to minimize the cost in order to extract profits from the rival firm, and a reduction in product competition helps internalize the externality. In a research joint venture the absence of R&D rivalry leads to contrary results. The main implication is that the validity of the Schumpeterian hypotheses depends on the extent of cooperation at the R&D stage.     

Skill‐biased heterogeneous firms,trade liberalization and the skill premium

We propose a theory that rising globalization and rising wage inequality are related because trade liberalization raises the demand facing highly competitive skill‐intensive firms. In our model, only the lowest‐cost firms participate in the global economy exactly along the lines of Melitz ( 2003 ). In addition to differing in their productivity, firms differ in their skill intensity. We model skill‐biased technology as a correlation between skill intensity and technological acumen, and we estimate this correlation to be large using firm‐level data from Chile in 1995. A fall in trade costs leads to both greater trade volumes and an increase in the relative demand for skill, as the lowest‐cost/most‐skilled firms expand to serve the export market while less skill‐intensive non‐exporters retrench in the face of increased import competition. This mechanism works regardless of factor endowment differences, so we provide an explanation for why globalization and wage inequality move together in both skill‐abundant and skill‐scarce countries. In our model countries are net exporters of the services of their abundant factor, but there are no Stolper‐Samuelson effects because import competition affects all domestic firms equally.     

Who Exports Better Quality Products to Smaller or More Distant Markets?

The role of across‐firm differences in product quality and firms' competitiveness in determining the spatial patterns of within‐product export unit values across destinations is examined in this paper. Using product level export data, it is shown that the average export unit value of a product shipped from the USA or Korea increases with distance and decreases with destination market's size. However, within‐product average unit values for products exported from China and India decrease with distance and increase with market size. To interpret these different spatial patterns of unit values across exporting countries, model of quality heterogeneity is developed in which firms differ in their workers' skill level and higher‐skilled workers show greater productivity in performing tasks that improve product quality. The model predicts that in relatively skill‐abundant countries, exporting firms specialize in high‐quality products using relatively cheap skilled labor, whereas, in relatively skill‐scarce countries, firms that produce lower‐quality products are more competitive.     

Adam Smith’s division of labor and structural changes

This paper considers two different cases of division of labor: (i) the subdivision of different operations in order to produce a particular product in a given firm or plant; (ii) the specialization of firms in the same industry. Division of labor of the former type is limited by demand for output of a particular firm or plant, while division of labor of the latter type is limited by demand for the industry as a whole. It is argued that, in the case of an industry producing a homogenous product, an increase in the scale of production of any particular firm is likely to be associated with changes in the internal division of labor. In the case of inter-firm division of labor, decreasing unit costs may result from lateral disintegration. Finally, in the case of an industry producing a composite commodity (that is, a commodity composed of many different sub-commodities), firms’, disequilibrium behavior may lead to concentration of each firm to fewer sub-commodities, in the anticipation of the entry of new firms, or as a result of it.     

Additive versus multiplicative trade costs and the gains from trade liberalizations

This paper addresses welfare effects from trade liberalization in a Melitz ( 2003 ) heterogeneous‐firms trade model including the empirically important per‐unit (i.e., additive) trade costs in addition to the conventional iceberg (i.e., multiplicative) and fixed trade costs. The novel contribution of the paper is the result that the welfare gain for a given increase in trade openness is higher for reductions in per‐unit (additive) trade costs than for reductions in iceberg (multiplicative) trade costs. The ranking derives from differences in intra‐industry reallocations and, in particular, from dissimilar impacts on the number of exporters (i.e., the extensive margin of trade).