nep-mic New Economics Papers
on Microeconomics
Issue of 2006‒06‒03
sixteen papers chosen by
Joao Carlos Correia Leitao
Universidade da Beira Interior

  1. One-Way Compatibility, Two-Way Compatibility and Entry in Network Industries. By Fabio M. Manenti; Ernesto Somma
  2. Open Source Development in a Differentiated Duopoly By Stephane Verani
  3. When Redistribution Leads to Regressive Taxation By Cyril Hariton; Gwenäel Piaser; Gwenaël Piaser
  4. New survey evidence on the pricing behaviour of Luxembourg firms By Patrick Lünnemann; Thomas Y. Mathä
  5. The Effect of Reputation on Selling Prices in Auctions By Oliver Gürtler; Christian Grund
  6. The Intensity of Incentives in Firms and Markets: Moral Hazard with Envious Agents By Björn Bartling; Ferdinand von Siemens
  7. Multiple Lending and Constrained Efficiency in the Credit Market By Andrea Attar; Eloisa Campioni; Gwenäel Piaser; Gwenaël Piaser
  8. Choosing Intellectual Protection: Imitation, Patent Strength and Licensing By David Encaoua; Yassine Lefouili
  9. Can a Newly Proposed Mechanism for Allocating Contracts in U.S. Electricity Wholesale Markets Lead to Lower Prices? A Game Theoretic Analysis By Vicki Knoblauch
  10. A strategic investment game with endogenous absorptive capacity. By Anna Hammerschmidt
  11. Product Choice and Product Switching By Stephen Redding; Andrew Bernard; Peter Schott
  12. Common Agency Games with Separable Preferences By Attar Andrea; Gwenäel Piaser; Nicolas Porteiro
  13. Quality Sorting and Networking: Evidence from the Advertising Agency Industry By Mohammad Arzaghi
  14. Afriat’s Theorem for General Budget Sets By Francoise Forges; Enrico Minelli
  15. On Delegation under Relational Contracts By Oliver Gürtler
  16. Consumer Preferences for Mass Customization By Dellaert, B.G.C.; Stremersch, S.

  1. By: Fabio M. Manenti (Dipartimento di Scienze Economiche "M. Fanno", Università di Padova, Via del Santo 33, 35123 PADOVA); Ernesto Somma (Dipartimento di Scienze Economiche, Università degli Studi di Bari, Via C. Rosalba 53, 70124 BARI)
    Abstract: We study the strategic choice of compatibility between two initially incompatible network goods in a two-stage game played by an incumbent and an entrant firm. Compatibility may be achieved by means of a converter. We derive a number of results under different assumptions about the nature of the converter (one-way vs two-way) and the existence of property rights. In the case of a two-way converter, which can only be supplied by the incumbent, incompatibility will result in equilibrium. When both firms can build a one-way converter and there are no property rights on the necessary technical specifications, the unique equilibrium involves full compatibility. Finally, when each firm has property rights on its technical specifications, full incompatibility and preemption are again observed at the equilibrium. With incompatibility, entry deterrence occurs for sufficiently strong network effects. The welfare analysis shows that the equilibrium compatibility regime is socially inefficient for most levels of the network effects.
    Keywords: Network externalities, one-way compatibility, two-way compatibility
    JEL: L13 L15 D43
  2. By: Stephane Verani (Department of Economics, The University of Western Australia)
    Abstract: Open source software is released under an open source licence giving individuals the right to use, modify, and redistribute freely the programs. This paper proposes a model of differentiated duopoly in which firms invest in the development of proprietary or open source software. The main findings are: (i) firms invest more when the products are substitutes; (ii) for substitute products, firms' investment in software development is greatest when the software is open source; (iii) for close to perfect complements, firms' investment in software development is greatest when the software is proprietary; and (iv) for substitute products, investment in open source software yields higher profits than investment in proprietary software.
    Keywords: Open Source Software, Differentiated Duopoly, Two-Stage Game, Bertrand Competition
    JEL: C72 D21 D43 L11 L13
    Date: 2006–02
  3. By: Cyril Hariton (Toulouse Business School); Gwenäel Piaser (Department of Economics, University Of Venice Cà Foscari); Gwenaël Piaser
    Abstract: We introduce labor contracts, in a framework of optimal redistribution: firms have some local market power and try to discriminate among heterogeneous workers. In this setting we show that if the firms have perfect information, i.e, they perfectly discriminate against workers and take all the surplus, the best tax function is flat. If the firms have imperfect information, i.e, if they offert incentive contracts, then (under some assumptions) the best redistributive taxation is regressive.
    Keywords: Income Taxation, Redistribution, Labor market, Multi-principals, Adverse selection, Mechanism design
    JEL: D21 D82 H21 L14
    Date: 2006
  4. By: Patrick Lünnemann (Banque centrale du Luxembourg, Monetary, Economic & Statistics Department, 2, Boulevard Royal, L-2983 Luxembourg, Luxembourg.); Thomas Y. Mathä (Banque centrale du Luxembourg, Monetary, Economic & Statistics Department, 2, Boulevard Royal, L-2983 Luxembourg, Luxembourg.)
    Abstract: This paper analyses the pricing behaviour of Luxembourg firms based on survey evidence. Luxembourg firms typically have low market share, many competitors and longstanding customer relationships. Price discrimination is frequently applied. A majority of firms use price review rules that include elements of state dependency. The median firm reviews and changes prices twice a year. The results suggest an almost equal share of firms applying forwardlooking, backward-looking and rules of thumb behaviour. The adjustment speed is faster when cost goes up and demand goes down than in the opposite cases. The most relevant theories explaining price rigidity are implicit contracts, cost-based pricing and explicit contracts. Increases in labour and other costs are the most important factors leading to price increases; for price reductions it is price reductions by competitors followed by declining labour costs.
    Keywords: Survey data, price setting, price rigidity, adjustment speed.
    JEL: C21 C22 C14
    Date: 2006–05
  5. By: Oliver Gürtler (Department of Economics, BWL II, University of Bonn, Adenauer-allee 24-42, D-53113 Bonn, Germany. Tel.:+49-228-739214, Fax:+49-228-739210; Christian Grund (Department of Economics and Business RWTH Aachen University Templergraben 59 D-52056 Aachen Germany Tel.:+49-241-8096381
    Abstract: In economic approaches it is often argued that reputation considerations influence the behavior of individuals or firms and that reputation influences the outcome of markets. Empirical evidence is rare though. In this contribution we argue that a positive reputation of sellers should have an effect on selling prices. Analyzing auctions of popular DVDs at eBay we, indeed, find support for this hypothesis. Secondary, we unmask the myth that it is promising for eBay sellers to let their auction end at the evening, when many potential buyers may be online.
    Keywords: Reputation, eBay feedback system, auction
    JEL: D44 D82 K12 L81
    Date: 2006–05
  6. By: Björn Bartling (; Ferdinand von Siemens (
    Abstract: While most market transactions are subject to strong incentives, transactions within Firms are often not incentivized. We offer an explanation for this observation based on envy among agents in an otherwise standard moral hazard model with multiple agents. Envious agents suffer if other agents receive a higher wage due to random shocks to their performance measures. The necessary compensation for expected envy renders incentive provision more expensive, which generates a tendency towards flat-wage contracts. Moreover, empirical evidence suggests that social comparisons like envy are more pronounced among employees within Firms than among individuals who interact only in the market. Flat-wage contracts are thus more likely to be optimal in Firms than in markets.
    Keywords: Envy, moral hazard, flat-wage contracts, within-Firm vs. market interactions
    JEL: D82 J3 M5
    Date: 2006–04
  7. By: Andrea Attar (Università di Roma, La Sapienza; LUISS, University of Rome); Eloisa Campioni (LUISS, University of Rome); Gwenäel Piaser (Department of Economics, University Of Venice Cà Foscari); Gwenaël Piaser
    Abstract: This paper studies the relationship between competition and incentives in an economy with financial contracts. We concentrate on non-exclusive credit relationships, those where an entrepreneur can simultaneously accept more than one contractual offer. Several homogeneous lenders compete on the contracts they offer to finance the entrepreneur's investment project. We model a common agency game with moral hazard, and we characterize its equilibria. As expected, notwithstanding the competition among the principals (lenders), non-competitive outcomes can be supported. In particular, positive profit equilibria are pervasive. We then provide a complete welfare analysis and show that all equilibrium allocations turn out to be constrained Pareto efficient.
    Keywords: Common Agency, Financial Markets, Efficiency
    JEL: D4 D6 G2
    Date: 2006
  8. By: David Encaoua; Yassine Lefouili
    Abstract: This paper investigates the choice of an intellectual protection regime for a process innovation. We set up a multi-stage model in which choosing between patent and trade secrecy is affected by three parameters: the patent strength defined as the probability that the right is upheld by the court, the cost of imitating a patented innovation relative to the cost of imitating a secret innovation, and the innovation size defined as the extent of the cost reduction. The choice of the protection regime is the result of two effects: the damage effect evaluated under the unjust enrichment doctrine and the effect of market competition that occurs under the shadow of infringement. We find that large innovations are likely to be kept secret whereas small innovations are always patented. Furthermore, medium innovations are patented only when patent strength is sufficiently high. Finally, we investigate a class of licensing agreements used to settle patent disputes between patent holders and their competitors.
    Keywords: patent, trade secrecy, imitation, licensing
    JEL: D45 L10 O32 O34
    Date: 2006
  9. By: Vicki Knoblauch (University of Connecticut)
    Abstract: This study of the wholesale electricity market compares the cost-minimizing performance of the auction mechanism currently in place in U.S. markets with the performance of a proposed replacement. The current mechanism chooses an allocation of contracts that minimizes a fictional cost calculated using pay-as-offer pricing. Then suppliers are paid the market clearing price. The proposed mechanism uses the market clearing price in the allocation phase as well as in the payment phase. In concentrated markets, the proposed mechanism outperforms the current mechanism even when strategic behavior by suppliers is taken into account. The advantage of the proposed mechanism increases with increased price competition.
    Keywords: strategic behavior, multi-unit auction, electricity, Bertrand competition
    JEL: C72 D44 L10 L94
    Date: 2004–04
  10. By: Anna Hammerschmidt (Department of Economics, Vienna University of Economics & B.A.)
    Abstract: R&D plays a dual role: First, it generates new knowledge and second, it develops a firm's absorptive capacity. Most of the existing strategic investment game models neglect, however, the second role of R&D. The aim of this paper is to incorporate the absorptive capacity hypothesis in such a model by endogenizing the spillover. A two-stage game is established and subsequently solved, looking for the subgame perfect Nash equilibria. Considering the comparative static properties of the model as well as the simulation results, a new effect appears: The "free-rider effect" of the models with exogenous spillover, which deteriorates the higher the spillover becomes, is now counteracted by the "absorptive capacity effect". It is found that firms will invest more in R&D to strengthen absorptive capacity when the spillover parameter is higher.
    JEL: O31 L13 C72
    Date: 2006–05
  11. By: Stephen Redding; Andrew Bernard; Peter Schott
    Abstract: This paper develops a model of endogenous product selection within industries by firms. The model is motivated by new evidence we present on the prevalence and importance of product changing activity by U.S. manufacturers. Three-fifths of continuing firms alter their product mix within an industry every five years, and added and dropped products account for a substantial portion of firm output. In the model, firms make decisions about both industry entry and product choice. Product choice is shaped by the interaction of heterogeneous firm characteristics and diverse product attributes. Changes in market conditions within an industry result in simultaneous adjustment along a number of margins, including both entry/exit and product choice.
    Keywords: Product selection, heterogeneous firms, product differentiation, sunk entry costs
    JEL: L11 D21 L60
    Date: 2005–10
  12. By: Attar Andrea (IDEI, University of Toulouse; Concordia University); Gwenäel Piaser (Department of Economics, University Of Venice Cà Foscari); Nicolas Porteiro (University Pablo de Olavide)
    Abstract: This paper examines the role of the direct mechanisms in common agency games. We show how the introduction of a separability condition on the preferences of the agent is sufficient for a version of the Revelation Principle to hold in finite generic games. The result goes through without imposing any restriction on the principals’ payoffs. Therefore, it is still possible to restrict attention to direct mechanisms without any loss of generality even when competition over contracts is considered.
    Keywords: Revelation Principle, Common Agency, Separable Preferences
    JEL: D82
    Date: 2006
  13. By: Mohammad Arzaghi
    Abstract: This paper provides a model of knowledge sharing and networking among single unit advertising agencies and investigates the implications of this model in the presence of heterogeneity in agencies’ quality. In a stylized screening model, we show that, under a modest set of assumptions, the separation outcome is a Pareto-undominated Nash equilibrium. That is, high quality agencies locate themselves in a high wage and rent area to sift out low quality agencies and guarantee their network quality. We identify a necessary condition for the separating equilibrium to exist and to reject the pooling equilibrium even in the presence of agglomeration economies from networking. We derive the maximum profit of an agency and show the condition has a directly testable implication in the empirical specification of the agency’s profit function. We use a sample of movers—existing agencies that relocate among urban areas—in order to extract a predetermined measure of their quality prior to relocation. We estimate the parameters of the profit function, using the Census confidential establishment-level data, and show that the necessary condition for separation is met and that there is strong separation and sorting on quality among agencies in their location decisions.
    Keywords: Advertising, Agglomeration, Industrial Concentration, Business Services, Discrete Choice, Knowledge Spillovers, Learning, Location Decision, Poisson Regression, Nested Logit, Screening, Separating Equilibrium, Sorting
    JEL: D82 D83 D85 L25 L84 M37 R12 R30
    Date: 2005–10
  14. By: Francoise Forges; Enrico Minelli
    Abstract: Afriat (1967) showed the equivalence of the strong axiom of revealed preference and the existence of a solution to a set of linear inequalities. From this solution he constructed a utility function rationalizing the choices of a competitive consumer. We extend Afriat’s theorem to a class of nonlinear budget sets. We thereby obtain testable implications of rational behavior for a wide class of economic environments, and a constructive method to derive individual preferences from observed choices. In an application to market games, we identify a set of observable restrictions characterizing Nash equilibrium outcomes.
    Keywords: GARP, rational choice, revealed preferences, market games, SARP, WARP
    JEL: C72 D11 D43
    Date: 2006
  15. By: Oliver Gürtler (Department of Economics, BWL II, University of Bonn, Adenauer-allee 24-42, D-53113 Bonn, Germany. Tel.:+49-228-739214, Fax:+49-228-739210
    Abstract: In this paper, a principal’s decision between delegating two tasks or handling one of the two tasks herself is analyzed. We assume that the principal uses both, formal contracts and informal agreements sustained by the value of future relationships (relational contracts) as incentive device. It is found that the principal is less likely to delegate both tasks in a dynamic setting than in a static one (where formal contracts are the only feasible incentive device), as handling one task herself enables a much wider use of relational contracts.
    Keywords: Job design, relational contracts, formal contracts, delegation
    JEL: D82 J33 L23 M52 M54
    Date: 2006–05
  16. By: Dellaert, B.G.C.; Stremersch, S. (Erasmus Research Institute of Management (ERIM), RSM Erasmus University)
    Abstract: Increasingly, firms adopt mass customization, which allows consumers to customize products by self-selecting their most preferred composition of the product for a predefined set of modules. For example, PC vendors such as Dell allow customers to customize their PC by choosing the type of processor, memory size, monitor, etc. However, how such firms configure the mass customization process determines the utility a consumer may obtain or the complexity a consumer may face in the mass customization task. Mass customization configurations may differ in four important ways ? we take the example of the personal computer industry. First, a firm may offer few or many product modules that can be mass customized (e.g., only allow consumers to customize memory and processor of a PC or allow consumers to customize any module of the PC) and few or many levels among which to choose per mass customizable module (e.g., for mass customization of the processor, only two or many more processing speeds are available). Second, a firm may offer the consumer a choice only between very similar module levels (e.g., a 17? or 18? screen) or between very different module levels (e.g., a 15? or 21? screen). Third, a firm may individually price the modules within a mass customization configuration (e.g., showing the price of the different processors the consumer may choose from) along with pricing the total product, or the firm may show only the total product price (e.g., the price of the different processors is not shown, but only the computer?s total price is shown). Fourth, the firm may show a default version (e.g., for the processor, the configuration contains a pre-selected processing speed, which may be a high-end or low-end processor), which consumers may then customize, or the firm may not show a default version and let consumers start from scratch in composing the product. The authors find that the choices that firms make in configuring the mass customization process affect the product utility consumers can achieve in mass customization. The reason is that the mass customization configuration affects how closely the consumer may approach his or her ideal product by mass customizing. Mass customization configurations also affect consumers? perception of the complexity of mass customization as they affect how many cognitive steps a consumer needs to make in the decision process. Both product utility and complexity in the end determine the utility consumers derive from using a certain mass customization configuration, which in turn will determine main outcome variables for marketers, such as total product sales, satisfaction with the product and the firm, referral behavior and loyalty. The study offers good news for those who wish to provide many mass customization options to consumers, because we find that within the rather large range of modules and module levels we manipulated in this study, consumers did not perceive significant increases in complexity, while they were indeed able to achieve higher product utility. Second, our results imply that firms when increasing the number of module levels, should typically offer consumers more additional options in the most popular range of a module and less additional options at the extremes. Third, pricing should preferably be presented only at the total product level, rather than at the module and product level. We find that this approach reduces complexity and increases product utility. Fourth, firms should offer a default version that consumers can use as a starting point for mass customization, as doing so minimizes the complexity to consumers. The best default version to start out with is a base default version because this type of default version allows the consumer to most closely approach his or her ideal product. The reason is that consumers when presented with an advanced default may buy a product that is more advanced than they actually need. We also found that expert consumers are ideal targets for mass customization offerings. Expert consumers experience lower complexity in mass customization and complexity has a less negative influence on product utility obtained in the mass customization process, all compared to novice consumers. In general, reducing complexity in the mass customization configuration is a promising strategy for firms as it not only increases the utility of the entire process for consumers, but also allows them to compose products that more closely fit their ideal product.
    Keywords: mass customization;consumer choice;complexity;utility;PC buying;mass customized products;customization;
    Date: 2004–11–17

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