nep-mic New Economics Papers
on Microeconomics
Issue of 2006‒03‒11
23 papers chosen by
Joao Carlos Correia Leitao
Universidade da Beira Interior

  1. Capacity Choice under Uncertainty: The Impact of Market Structure By Veronika Grimm; Gregor Zoettl
  2. Vertical differentiation, network externalities and compatibility decisions : an alternative approach. By Hend Ghazzai; Rim Lahmandi-Ayed
  5. Efficient Intra-household Allocations and Distribution Factors: Implications and Identification By François Bourguignon; Martin Browning; Pierre-André Chiappori
  6. Insurance and Incentives for Medical Innovation By Alan M. Garber; Charles I. Jones; Paul M. Romer
  7. Contractual Incentive Provision and Commitment in Rent-Seeking Contests By Oliver Gürtler
  8. Supermarket Pricing Strategies By Ellickson, Paul; Misra, Sanjog
  10. Is Demand-Pulled Innovation Equally Important in Different Groups of Firms? By Mariacristina Piva; Marco Vivarelli
  11. "Role of Linking Mechanisms in Multitask Agency with Hidden Information" By Hitoshi Matsushima; Koichi Miyazaki; Nobuyuki Yagi
  12. Prediction Markets in Theory and Practice By Justin Wolfers; Eric Zitzewitz
  13. Electricity Restructuring and Regulation in the Provinces: Ontario and Beyond By Donald N. Dewees
  14. Should You Allow Your Agent to Become Your Competitor? .On Non-Compete Agreements in Employment Contracts By Matthias Kräkel; Dirk Sliwka
  15. A Duality Procedure to Elicit Nonlinear Multiattribute Utility Functions. By Francisco J. André; Laura Riesgo
  16. Classification of Network Formation Models By Jochen Moebert
  17. Agency-Based Asset Pricing By Gary Gorton; Ping He
  18. Jefficiency vs. Efficiency in Social Network Models By Jochen Moebert
  19. An Analysis of Option Pricing in the Japanese Market By Satoru Kanoh; Asuka Takeuchi
  20. Layoffs as Part of an Optimal Incentive Mix: Theory and Evidence By Anders Frederiksen; Elõd Takáts
  21. R&D of Multinationals in China: Structure, Motivations and Regional Difference By Kazuyuki Motohashi
  22. Sequential Formation of Coalitions through Bilateral Agreements in a Cournot Setting By Inés Macho-Stadler; David Pérez-Castrillo; Nicolás Porteiro
  23. Efficiency in Deregulated Electricity Markets: Offer Cost Minimization vs. Payment Cost Minimization Auction By Rimvydas Baltaduonis

  1. By: Veronika Grimm; Gregor Zoettl
    Abstract: We analyze a market game where firms choose capacities under uncertainty about future market conditions and make output choices after uncertainty has unraveled. We show existence and uniqueness of equilibrium under imperfect competition and provide an intuitive characterization of equilibrium investment. We show that investment in oligopoly, in the first and second best solution can be unambiguously ranked, in particular investment incentives are highest in the First Best solution and lowest under imperfect competition. We finally demonstrate that intervention of a social planer only at the production stage leads to strategic uncertainty at the investment stage and moreover decreases total investment below the level obtained under imperfect competition.
    Keywords: Investment incentives, demand uncertainty, cost uncertainty, Cournot competition, First Best, Second Best, capacity obligations, spot market regulation
    JEL: D43 L13 D41 D42 D81
    Date: 2006–02–28
  2. By: Hend Ghazzai (CES-CERMSEM et LEGI-Ecole Polytechnique de Tunisie); Rim Lahmandi-Ayed (LEGI-Ecole Polytecnique de Tunisie)
    Abstract: We characterize the equilibrium of a game in vertically differentiated market which exhibits network externalities. There are two firms, an incumbent and a potential entrant. Compatibility means in our model that the inherent qualities of the goods are close enough. By choosing its quality, the entrant chooses in the same time to be compatible or not. The maximal quality difference that allows compatibility i.e the compatibility interval is chosen by the incumbent which involves costs increasing with the width of that interval. We show that in order to have two active firms at price equilibrium, the sufficient condition on the market size of a standard vertical differentiation model remains valid under compatibility. However, an additional condition on the firms' qualities is needed under incompatibility. For a small quality segment, the incumbent can block entry choosing an empty compatibility interval. At the subgame perfect equilibrium, incompatibility prevails if the quality segment is large and the compatibility costs are high. Compatibility prevails for sufficiently large quality segments and low costs of compatibility. Finally there is no entry if the quality segment is small and the compatibility costs are high.
    Keywords: Vertical differentiation, compatibility, network externalities.
    JEL: L13 L15 D43
    Date: 2006–02
  3. By: Veronika Grimm (Universidad de Alicante); Gregor Zoettl (CORE, Université catholique de Louvain)
    Abstract: In this paper we analyze incentives to invest in capacity prior to asequence of Cournot spot markets with varying demand. We compareequilibrium investment in the absence and in presence of the possibility to tradeon forward markets. We find that the possibility to trade forwards reducesequilibrium investments.
    Keywords: Investment incentives, demand fluctuations, forward markets
    JEL: D43 L13
    Date: 2006–02
  4. By: Ramón Faulí-Oller (Universidad de Alicante); Lluís Bru (Universitat de les Illes Balears); Joel Sandonís (Universidad de Alicante)
    Abstract: We analyze third degree price discrimination by an upstream monopolistto a continuum of heterogeneous downstream firms. The novelty of ourapproach is to recognize that customizing prices may be costly, whichintroduces an interesting trade-off. As a consequence, partial pricediscrimination arises in equilibrium. In particular, we show that inefficientdownstream firms receive personalized prices whereas efficient firms arecharged a uniform price. The extreme cases of complete price discriminationand uniform price arise in our setting as particular cases, depending on the costof customizing prices.
    Keywords: Price discrimination, input markets
    JEL: D4 L11 L12
    Date: 2006–02
  5. By: François Bourguignon (World Bank); Martin Browning (Department of Economics, University of Copenhagen); Pierre-André Chiappori (Department of Economics, University of Chicago)
    Abstract: This paper provides an exhaustive characterization of testability and identifiability issues in the collective framework in the absence of price variation; it thus provides a theoretical underpinning for a number of empirical works that have been developed recently. We first provide a simple and general test of the Pareto efficiency hypothesis, which is consistent with all possible assumptions on the private or public nature of goods, all possible consumption externalities between household members, and all types of interdependent individual preferences and domestic production technology; moreover, the test is proved to be necessary and sufficient. We then provide a complete analysis of the identification problem; we show under which assumptions it is possible to identify, from the observation of the household consumption of private goods, the allocation of these goods within the household as well as the Engel curves of individual household members.
    Keywords: intrahousehold allocation; collective models; identification; sharing
    JEL: D13
    Date: 2006–02
  6. By: Alan M. Garber; Charles I. Jones; Paul M. Romer
    Abstract: This paper studies the interactions between health insurance and the incentives for innovation. Although we focus on pharmaceutical innovation, our discussion applies to other industries producing novel technologies for sale in markets with subsidized demand. Standard results in the growth and productivity literatures suggest that firms in many industries may possess inadequate incentives to innovate. Standard results in the health literature suggest that health insurance leads to the overutilization of health care. Our study of innovation in the pharmaceutical industry emphasizes the interaction of these incentives. Because of the large subsidies to demand from health insurance, limits on the lifetime of patents and possibly limits on monopoly pricing may be necessary to ensure that pharmaceutical companies do not possess excess incentives for innovation.
    JEL: I1 O30
    Date: 2006–03
  7. By: Oliver Gürtler (Department of Economics, BWL II, University of Bonn, Adenauerallee 24-42, D-53113 Bonn, Germany. Tel.:+49-228-739214, Fax:+49-228-739210.
    Abstract: In this paper, we consider a symmetric rent-seeking contest, where employees lobby for a governmental contract on behalf of .rms. The only verifiable information is which firm is assigned the contract. We derive the optimal wage contracts of the employees and analyze, whether commitment by determining the wage contract prior to the competitor is profitable. This is indeed the case, i.e. firms prefer to move first in the wage-setting subgame. This complements previous work on rent-seeking contests emphasizing that commitment via rent-seeking expenditures is unprofitable in symmetric contests.
    Keywords: Contest, First-Mover Advantage, Commitment, Wage Contract
    JEL: D72 M52
    Date: 2006–03
  8. By: Ellickson, Paul; Misra, Sanjog
    Abstract: Most supermarket firms choose to position themselves by offering either "Every Day Low Prices" (EDLP) across several items or offering temporary price reductions (promotions) on a limited range of items. While this choice has been addressed from a theoretical perspective in both the marketing and economic literature, relatively little is known about how these decisions are made in practice, especially within a competitive environment. This paper exploits a unique store level dataset consisting of every supermarket operating in the United States in 1998. For each of these stores, we observe the pricing strategy the firm has chosen to follow, as reported by the firm itself. Using a system of simultaneous discrete choice models, we estimate each store's choice of pricing strategy, conditional on its expectation over the choices of its rivals. We find evidence that firms cluster by strategy, choosing actions that agree with those of its rivals. We also find a significant impact of various demographic and firm characteristics, providing some qualified support for several specific predictions from marketing theory.
    Keywords: EDLP, promotional pricing, positioning strategies, supermarkets, discrete games
    JEL: M31 L11 L81
    Date: 2006
  9. By: Osamu Keyda (Kumamoto Gakuen University)
    Abstract: This paper presents an analysis of market equilibrium under the circumstances withseveral discrete economic conditions by using pure exchange economy model. First,as preliminary analysis, it will show the ‘temporal’ market equilibrium under a givendistribution of population over the dierent circumstances in section 2. Next, in section3 our study will prove the existence of market equilibrium in the case that economicagents can choose their economic conditions freely for their utility maximization. Finallyour research tries to approximate our model to the residential location model throughthe specified assumptions on initial endowments and agent’s preference, and it derivessome properties of equilibrium consumptions and prices.
    Keywords: equilibrium, local goods, excess utility
    JEL: D51 R13 R20
    Date: 2006–02
  10. By: Mariacristina Piva (Catholic University of Piacenza); Marco Vivarelli (Catholic University of Piacenza, CSGR Warwick, Max Planck Institute of Economics Jena and IZA Bonn)
    Abstract: Previous empirical literature - mainly cross-sectional - has tested the demand-pull hypothesis and found that overall, evidence does not conflict with the idea that innovation may be driven by output. Using a balanced panel of 216 Italian manufacturing firms over the 1995-2000 period, and checking for fixed effects, time, sectoral and size dummies and for the pathdependent nature of R&D, we also find a (barely significant) role of sales in inducing R&D expenditures. However, at the micro level, the demand-pull effect plays a varying role for the different sub-samples of firms. In particular, exporting firms, those which are liquidityconstrained, those not receiving public subsidies and those not heading a business group, seem to be particularly sensitive to sales in deciding their R&D expenditures. These microeconometric results have been obtained using a Least Squares Dummy Variable Corrected (LSDVC) estimator, a recently-proposed panel data technique particularly suitable for small samples.
    Keywords: R&D expenditures, demand-pull, innovative firms, LSDVC estimator
    JEL: O31
    Date: 2006–02
  11. By: Hitoshi Matsushima (Faculty of Economics, University of Tokyo); Koichi Miyazaki (Pennsylvania State University); Nobuyuki Yagi (Graduate School of Economics, Nagoyagakuin University)
    Abstract: We investigate the adverse selection problem where a principal delegates multiple tasks to individuals. The individuals form a group as a single agent and share their private signals in order to maximize their average payoff. We characterize the virtually implementable social choice functions by using the linking mechanism proposed by Jackson and Sonnenschein (2005) that restricts the message spaces. The principal does not require any incentive wage schemes and can therefore avoid any information rent and welfare loss due to risk aversion. We show the resemblance between the functioning of this message space restriction and that of incentive wage schemes.
    Date: 2006–02
  12. By: Justin Wolfers (Wharton, University of Pennsylvania, CEPR, NBER and IZA Bonn); Eric Zitzewitz (Stanford GSB)
    Abstract: Prediction Markets, sometimes referred to as "information markets", "idea futures" or "event futures", are markets where participants trade contracts whose payoffs are tied to a future event, thereby yielding prices that can be interpreted as market-aggregated forecasts. This article summarizes the recent literature on prediction markets, highlighting both theoretical contributions that emphasize the possibility that these markets efficiently aggregate disperse information, and the lessons from empirical applications which show that market-generated forecasts typically outperform most moderately sophisticated benchmarks. Along the way, we highlight areas ripe for future research.
    Keywords: prediction markets, information markets, information aggregation
    JEL: C53 D8 G14
    Date: 2006–03
  13. By: Donald N. Dewees
    Abstract: Competitive electricity markets are artificial markets with extensive rules for all participants arising from the complex interconnections of the electricity network. Governments or regulatory agencies oversee the market design process and the operation and maintenance of the market, so market design is necessarily a political process. The conceptual design of the market must recognise the political forces that will operate on the market design process so that the political process will not thwart the intended outcome of the market as it has in some jurisdictions including Ontario. The limited ability of consumers to understand changes in the electricity sector in the short run poses a real constraint on what can be achieved politically. Letting the market set the price means that governments cannot ensure any particular future price level and both theory and experience tell us that prices may increase after restructuring (California, Ontario, Alberta). This makes it difficult to sell restructuring to consumers who will be interested in the price they pay and not much interested in abstractions like efficiency. Another challenge for electricity restructuring is that the starting points differ from one jurisdiction to another and the starting points matter. The problems are different if you begin with a crown monopoly than if you have investor-owned utilities; if expected prices are higher than recent prices rather than lower; if governments have been deeply involved in the electricity sector rather than distant from it; if the public has experience with stable electricity prices rather than fluctuating prices. Finally, the situation in neighbouring jurisdictions matters as well. Restructuring in a low-price jurisdiction surrounded by high prices will increase the prospect of price increases at home, while a high-price island is more likely to see its prices decline. If workable competition will be difficult to achieve at home, strong interties to neighbouring jurisdictions can improve competitive performance if the market is appropriately designed. Air pollution, like electricity, moves across borders, so one must assess and evaluate the pollution implications of competition and make any appropriate adjustments to the market design.
    Keywords: electricity restructuring, electric utilities, market design
    JEL: L94
  14. By: Matthias Kräkel (University of Bonn, Adenauerallee 24-42, D-53113 Bonn, Germany, tel: +49 228 733914, fax: +49 228 739210.; Dirk Sliwka (University of Cologne, Herbert-Lewin-Str. 2, D-50931 Köln, Germany, tel: +49 221 470-5888, fax: +49 221 470-5078.
    Abstract: We discuss a principal-agent model in which the principal has the opportunity to include a non-compete agreement in the employment contract. We show that if the agent faces limited liability and there is an incentive problem the principal prefers not to impose such a clause if and only if the principal's profits from entering the market are sufficiently large relative to the agent's outside option. If the principal can impose a fine on the agent for leaving the firm, she will never prefer a non-compete agreement.
    Keywords: fine, incentives, incomplete contracts, non-compete agreements
    JEL: D21 J3 K1 M5
    Date: 2006–03
  15. By: Francisco J. André (Department of Economics, Universidad Pablo de Olavide); Laura Riesgo (Department of Economics, Universidad Pablo de Olavide)
    Abstract: The practical implementation of the Multiattribute Utility Theory is limited, partly for the lack of operative methods to elicit the parameters of the Multiattribute Utility Function, particularly when this function is not linear. As a consequence, most studies are restricted to linear specifications, which are easier to estimate and to interpret. We propose an indirect method to elicit the parameters of a nonlinear utility function to be compatible with the actual behaviour of decision makers, rather than with their answers to direct surveys. The idea rests on approaching the parameter estimation problem as a dual of the decision problem and making the observed decisions to be compatible with a rational decision making process.
    Keywords: Multiple-Criteria Analysis, Multi-Attribute Utility Function, Simulation, Agriculture.
    JEL: C61 Q12
    Date: 2006–03
  16. By: Jochen Moebert (Darmstadt University of Technology, Department of Economics)
    Abstract: Social network formation models are often compared by their network structures, which satisfy specific equilibrium or welfare properties. Here, we concentrate on welfare criteria and define properties of utility function which are causal for certain network structures. We hope the identification of different properties of utility function will enhance the understanding of the relationship of different network formation models. If this line of research is continued, a kind of engineering of network formation models might arise such that actual social networks can be directly described by appropriate utility functions.
    Keywords: social networks, network formation, rival networks, welfare, efficiency
    JEL: D60 D85 L14 Z13
    Date: 2006–03
  17. By: Gary Gorton; Ping He
    Abstract: We analyze the interaction between managerial decisions and firm value/asset prices by embedding the standard agency model of the firm into an otherwise standard asset pricing model. When the manager-agent's compensation depends on the firm's stock price performance, stock prices are set to induce the creation of future cash flows, instead of representing the discounted value of exogenous cash flows, as in the standard model. In our case, stock prices are formed via trading in the market to induce the managers to hold the number of shares consistent with the optimal effort level desired by the outside investors. We compare two price formation mechanisms, corresponding to two firm ownership structures. In the first, stock prices are formed competitively among a continuum of dispersed investors. In the second, stock prices are set by a single block shareholder, as a bargaining solution. Under both mechanisms there are persistent, dynamic, patterns of asst prices, The level of the equity premium and the return volatility depend on the risk aversion of the agents in the economy and the ownership structure of firms.
    JEL: G1
    Date: 2006–03
  18. By: Jochen Moebert (Darmstadt University of Technology, Department of Economics)
    Abstract: The mainly used welfare criterion in the social network literature is Bentham´s utilitarian concept. The shortcomings of this concept are well-known. We compare the outcomes of the utilitarian concept with the Nash social welfare function. By using a Taylor approximation we deduce a formula which allows the direct comparison of both concepts. The implications of welfare considerations of important network formation models are evaluated by using the multiplicative concept. We introduce a new symmetric connection model which is related to Nash´s welfare function in the same way as the original model is related to the utilitarian function. Based on the observation that heavy tail distributions like the power law distribution and the Pareto distribution can be explained by multiplicative structures we propose to use multiplicative utility functions in social network models. Furthermore, multiplicative utility and welfare functions together exhibit favorable characteristics both in normative and positive terms. Many empirically observed social networks have structures which are better modelled by multiplicative functions. From the normative perspective, multiplicative functions might be attractive since the Nash product introduces some form of justice.
    Keywords: social networks, welfare, efficiency, Nash product, jefficiency, justice
    JEL: A13 D11 D23 D61 D63 L14 Z13
    Date: 2006–03
  19. By: Satoru Kanoh; Asuka Takeuchi
    Date: 2006–03
  20. By: Anders Frederiksen (Stanford University); Elõd Takáts (Princeton University)
    Abstract: Firms offer highly complex contracts to their employees. These contracts contain a mix of various incentives, such as fixed wages, bonuses, promise of promotion, and threat of firing. This paper aims at explaining the reason why this incentive- mix arises. In particular, the model focuses on why firms are combining promotions and bonuses with firing. The theoretical model proposed is a job-assignment model with heterogeneous employees. In this model the firm is concerned about job assignment, because the overall productivity of the firm depends upon the quality of the employees and their allocation to jobs. The model shows that firing has a dual role. Firing creates incentives for the employees, and it is used as a sorting device that allows the firm to improve workforce quality. Thus, quality-concerned firms might want to combine cost-efficient incentives such as promotions and bonuses with firing. To comply with the Gibbons and Waldman critique, a large set of the model’s broader predictions is stated explicitly and tested on the personnel records from a large pharmaceutical company. The model’s predictions are shown to be consistent with the data.
    Keywords: personnel economics, incentive mix, layoffs.
    JEL: J30 J41 M50
    Date: 2006
  21. By: Kazuyuki Motohashi
    Abstract: In this paper, the motivations of R&D by multinationals are investigated by using a large firm level dataset from Chinese official statistics on science and technology activities. Growing intensity of R&D activities is found both for foreign owned and domestic firms. But, it is also found that the R&D intensity at foreign owned firms is relatively smaller. This may be due to the fact that foreign owned firms are operating by relying of technological capabilities at home. Statistical analysis confirms that the major motivation of foreign R&D in China is "market driven" instead of "technological driven" or "human resource driven". However, there is a great variation of foreign R&D strategy across regions. Market driven R&D is found mainly in Guangdong, which is called a world IT factory, and does not have strong universities or PRIs. In contrast, R&D strategy in Beijing is oriented toward technology driven approach, because we can find a cluster of scientific institutions there. Shanghai, with both a large industrial base as well as strong science sector, is in-between.
    Date: 2006–02
  22. By: Inés Macho-Stadler (Department of Economics, Universidad Autónoma de Barcelona); David Pérez-Castrillo (Department of Economics, Universidad Autónoma de Barcelona); Nicolás Porteiro (Department of Economics, Universidad Pablo de Olavide)
    Abstract: We study a sequential protocol of endogenous coalition formation based on a process of bilateral agreements among the players. We apply the game to a Cournot environment with linear demand and constant average costs. We show that the final outcome of any Subgame Perfect Equilibrium of the game is the grand coalition, provided the initial number of firms is high enough and they are sufficiently patient.
    Keywords: Coalition formation, bilateral agreements, Cournot.
    JEL: C72 D62 D40
    Date: 2006–02
  23. By: Rimvydas Baltaduonis (University of Connecticut)
    Abstract: This study of the wholesale electricity market compares the efficiency performance of the auction mechanism currently in place in U.S. markets with the performance of a proposed mechanism. The analysis highlights the importance of considering strategic behavior when comparing different institutional systems. We find that in concentrated markets, neither auction mechanism can guarantee an efficient allocation. The advantage of the current mechanism increases with increased price competition if market demand is perfectly inelastic. However, if market demand has some responsiveness to price, the superiority of the current auction with respect to efficiency is not that obvious. We present a case where the proposed auction outperforms the current mechanism on efficiency even if all offers re ect true production costs. We also find that a market designer might face a choice problem with a tradeoff between lower electricity cost and production efficiency. Some implications for social welfare are discussed as well.
    Keywords: strategic behavior, multi-unit auction, efficiency, electricity
    JEL: C72 D44 D61 L94
    Date: 2006–03

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