nep-mic New Economics Papers
on Microeconomics
Issue of 2007‒03‒10
fifteen papers chosen by
Joao Carlos Correia Leitao
University of the Beira Interior

  1. Downstream Competition, Bargaining and Welfare By George Symeonidis
  2. Strategic Quality Competition and the Porter Hypothesis. By Francisco J. André; Paula González; Nicolás Porteiro
  3. A Structural Empirical Analysis of Retail Banking Competition: the Case of Hungary By József Molnár; Márton Nagy; Csilla Horváth
  4. Integration and Separation with Costly Demand Information By Elisabetta Iossa; Francesca Stroffolini
  5. Selling to Consumers with Endogenous Types By Jan Boone; Joel Shapiro
  6. Persistent Price Dispersion in Online Markets By Michael R. Baye; John Morgan; Patrick Scholten
  8. The Groucho Effect of Uncertain Standards By Rick Harbaugh; John W. Maxwell; Beatrice Roussillon
  9. Strategic Complementarities and Search Market Equilibrium By Michael T. Rauh
  10. Generic entry into a regulated pharmaceutical market By Iván Moreno Torres; Jaume Puig; Joan-Ramon Borrell-Arqué
  11. Intellectual Property as a Carrot for Innovators Using Game Theory to Show the Limits of the Argument By Christoph Engel
  12. Are Sunk Costs a Barrier to Entry? By Cabral, Luís M B; Ross, Thomas
  13. Best-reply matching in Akerlof’s market for lemons. By Gisèle Umbhauer
  14. Learning-by-Doing, Organizational Forgetting and Industry Dynamics By Besanko, David; Doraszelski, Ulrich; Kryukov, Yaroslav; Satterthwaite, Mark
  15. Econometric Estimation of Scale and Scope Economies Within the Port Sector: A Review By Beatriz Tovar; Sergio Jara-Díaz; Lourdes Trujillo

  1. By: George Symeonidis
    Abstract: I analyse the effects of downstream competition when there is bargaining between downstream firms and upstream agents (firms or unions). When bargaining is over a uniform input price, a decrease in the intensity of competition (or a merger) between downstream firms may raise consumer surplus and overall welfare. When bargaining is over a two-part tariff, a decrease in the intensity of competition reduces downstream profits and upstream utility and raises consumer surplus and overall welfare. In both cases, standard welfare results of oligopoly theory can be reversed: less competition can be unprofitable for firms and/or beneficial for consumers and society as a whole.
    Date: 2007–03–02
  2. By: Francisco J. André (Department of Economics, Universidad Pablo de Olavide); Paula González (Department of Economics, Universidad Pablo de Olavide); Nicolás Porteiro (Department of Economics, Universidad Pablo de Olavide)
    Abstract: In this paper we provide a theoretical foundation for the Porter hypothesis in a context of quality competition. We use a duopoly model of vertical product differentiation where firms simultaneously choose the environmental quality of the good they produce (which can be either high or low) and, afterwards, engage in price competition. In this simple setting, we show that a Nash equilibrium of the game with low quality could be Pareto dominated by another strategy profile in which both firms produce the high environmental quality good. We then show how, in this case, the introduction of a penalty to any firm that produces the low environmental quality can result in an increase in both firms' profits. The impact of the policy on consumers depends on the effect of a quality shift on the cost structure of firms.
    Keywords: environmental quality, vertical differentiation, prisoner's dilemma, environmental regulation, Porter hypothesis.
    JEL: L13 L51 Q55 Q58
    Date: 2007–02
  3. By: József Molnár (Bank of Finland); Márton Nagy (Magyar Nemzeti Bank); Csilla Horváth (Radboud University Nijmegen, The Netherlands)
    Abstract: In this paper we analyze the degree of competition in the Hungarian household credit and deposit markets. We estimate discrete-choice, multinomial logit deposit service and loan demand functions for each bank and calculate the corresponding price elasticities. Two models of the banking industry are considered: a static, differentiated product Nash-Bertrand oligopoly (as non-collusive benchmark) and a cartel. With estimated marginal costs and observed interest rates we calculate the price-cost margins and compare these to the theoretically implied ones. We find that in our sample period the competition in the Hungarian banking sector is low, i.e. price-cost margins are high.
    Keywords: Demand, discrete choice, product differentiation, banking, market power.
    JEL: G21 L11 L13
    Date: 2007
  4. By: Elisabetta Iossa; Francesca Stroffolini
    Abstract: We consider an industry characterized by a regulated natural monopoly in the upstream market and Cournot competition with demand uncertainty in the unregulated downstream market. The realization of demand cannot be observed by the regulator, whilst it can be privately observed at some cost by the upstream monopolist. Information acquisition is also unobservable. We study whether it is better to allow the monopolist to operate in the downstream market (integration) or instead to exclude it (separation). We show that asymmetric information on demand favours separation but unobservability of information acquisition favours integration.
    Keywords: Information acquisition, liberalization and separation
    JEL: D82 D83 L5
    Date: 2007–01
  5. By: Jan Boone; Joel Shapiro
    Abstract: For many goods (such as experience goods or addictive goods), consumers’ preferences may change over time. In this paper, we examine a monopolist’s optimal pricing schedule when current consumption can affect a consumer’s valuation in the future and valuations are unobservable. We assume that consumers are anonymous, i.e. the monopolist can’t observe a consumer’s past consumption history. For myopic consumers, the optimal consumption schedule is distorted upwards, involving substantial discounts for low valuation types. This pushes low types into higher valuations, from which rents can be extracted. For forward looking consumers, there may be a further upward distortion of consumption due to a reversal of the adverse selection effect; low valuation consumers now have a strong interest in consumption in order to increase their valuations. Firms will find it profitable to educate consumers and encourage forward looking behavior.
    Keywords: Endogenous types, experience goods, addictive goods, price discrimination
    JEL: D42 D82 L12
    Date: 2006–08
  6. By: Michael R. Baye (Department of Business Economics and Public Policy, Indiana University Kelley School of Business); John Morgan (Haas School of Business and Department of Economics, University of California, Berkeley); Patrick Scholten (Bentley College)
    Abstract: Using data from one of the Internet’s leading price comparison sites for consumer electronics products, we present evidence for the persistence of price dispersion for 36 homogeneous products. The markets for these products are “thick” with an average of over 20 firms selling each product. We show that prices do not converge to the “law of one price” even after an 18 month period. This finding is robust to controls for differences in shipping charges and inventories. Further, we show that product life cycle effects lead to changes in the number of competing firms and the range of price dispersion consistent with the theoretical predictions of the Varian (1980) model. The average number of competing firms declines from about 28 to 10 during the final five months of our dataset. Over this same period, the average range in prices decreases from about 75 percent to 30 percent. After accounting for firm heterogeneities in costs, branding, reputation, trust, product availability and shipping costs, 28 percent of the variation in prices charged for homogeneous products remains unexplained. This is also consistent with the Varian model.
    Keywords: Price dispersion, Internet, Law of One Price
    JEL: D4 D8 M3 L13
    Date: 2006
  7. By: Francisco Martínez-Sánchez (Universidad de Alicante)
    Abstract: We analyze the roles of the government and the incumbent in preventing piracy, and the reasons and incentives why a pirate would want to be a leader in prices. The framework of analysis used is a duopoly model of vertical product differentiation with price competition, where both incumbent and pirate are committed to keep their prices. We find that both government and incumbent have a key role in avoiding the entry of the pirate. We show that the government will not help the incumbent to become a monopolist, even if he installs an antipiracy system, because a monopoly provides the lowest social welfare. However, he will let the pirate enters as a follower or as a leader, or encourage the incumbent to deter the entry of the pirate, which depends on the technology of the government for monitoring piracy. The pirate decides to become a leader to avoid being brought down by the incumbent and the government, although the leader's profit is lower than the follower's profit. Finally, we find that high-income countries with cheaper monitoring technology have lower piracy rates.
    Keywords: Pirate, Incumbent, Government, Price Leadership, Copy, Monitoring Piracy, Income
    JEL: K42 L13 L86
    Date: 2007–03
  8. By: Rick Harbaugh (Department of Business Economics and Public Policy, Indiana University Kelley School of Business); John W. Maxwell (Department of Business Economics and Public Policy, Indiana University Kelley School of Business); Beatrice Roussillon
    Abstract: Consumers are rarely sure of the exact standard that product labels and other certificates of quality represent. We show that any such uncertainty creates a “Groucho effect” in which seeing that a product has a label leads consumers to infer that the standard for the label itself is not very demanding. Label adoption is therefore always less likely to be an equilibrium than without uncertainty over the standard, and if it is an equilibrium it is always less informative than without such uncertainty. The Groucho effect leads to an information externality so better firms are reluctant to adopt labels if worse firms adopt them. Applying the model to eco-labels, we find that industry groups, governments, and NGOs can increase label adoption by publicizing labeling criteria, by encouraging consumers to expect label adoption when there are multiple equilibria, and by setting high standards that are less likely to be devalued by low quality firms.
    Keywords: Eco-labels, disclosure, certification, persuasion, standards
    JEL: L15 L21 D82 Q00
    Date: 2006–11
  9. By: Michael T. Rauh (Department of Business Economics and Public Policy, Indiana University Kelley School of Business)
    Abstract: In this paper, we apply supermodular game theory to the equilibrium search literature with sequential search. We identify necessary and sufficient conditions for strategic complementarities and prove existence of search market equilibrium. When firms are identical, the Diamond Paradox obtains and is robust within the class of search cost densities that are small near zero and support strategic complementarities. Price dispersion is therefore inherently incompatible with strategic complementarities. Finally, we show that a major criticism of the literature, that agents act as if they know the distribution of prices, can be justified in the sense of convergent best response dynamics.
    Keywords: Diamond Paradox, price dispersion, search, strategic complementarities
    JEL: L0 D43 D83
    Date: 2006
  10. By: Iván Moreno Torres; Jaume Puig; Joan-Ramon Borrell-Arqué
    Abstract: The aim of this paper is to analyse empirically entry decisions by generic firms into markets with tough regulation. Generic drugs might be a key driver of competition and cost containment in pharmaceutical markets. The dynamics of reforms of patents and pricing across drug markets in Spain are useful to identify the impact of regulations on generic entry. Estimates from a count data model using a panel of 86 active ingredients during the 1999–2005 period show that the drivers of generic entry in markets with price regulations are similar to less regulated markets: generic firms entries are positively affected by the market size and time trend, and negatively affected by the number of incumbent laboratories and the number of substitutes active ingredients. We also find that contrary to what policy makers expected, the system of reference pricing restrains considerably the generic entry. Short run brand name drug price reductions are obtained by governments at the cost of long run benefits from fostering generic entry and post-patent competition into the markets.
    Keywords: Entry; Generic Drugs; Pharmaceutical industry; Reference pricing
    JEL: I11 L11 L65
    Date: 2007–02
  11. By: Christoph Engel (Max Planck Institute for Research on Collective Goods, Bonn)
    Abstract: Policymakers all over the world claim: no innovation without protection. For more than a century, critics have objected that the case for intellectual property is far from clear. This paper uses a game theoretic model to organise the debate. It is possible to model innovation as a prisoner's dilemma between potential innovators, and to interpret intellectual property as a tool for making cooperation the equilibrium. However, this model rests on assumptions about cost and benefit that are unlikely to hold, or have even been shown to be wrong, in many empirically relevant situations. Moreover, even if the problem is indeed a prisoner's dilemma, in many situations intellectual property is an inappropriate cure. It sets incentives to race to be the first, or the last, to innovate, as the case may be. In equilibrium, the firms would have to randomise between investment and non-investment, which is unlikely to work out in practice. Frequently, firms would have to invent cooperatively, which proves difficult in larger industries.
    Keywords: intellectual property, game theory
    JEL: C72 O31 K11
    Date: 2007–02
  12. By: Cabral, Luís M B; Ross, Thomas
    Abstract: The received wisdom is that sunk costs create a barrier to entry - if entry fails, then the entrant, unable to recover sunk costs, incurs greater losses. In a strategic context where an incumbent may prey on the entrant, sunk entry costs have a countervailing effect: they may effectively commit the entrant to stay in the market. By providing the entrant with commitment power, sunk investments may soften the reactions of incumbents. The net effect may imply that entry is more profitable when sunk costs are greater.
    Keywords: barriers to entry; sunk costs
    JEL: L13
    Date: 2007–03
  13. By: Gisèle Umbhauer
    Abstract: The paper studies Akerlof's market for lemons in a new way. We firstly construct mixed Perfect Bayesian Nash equilibria in which all qualities are sold on the market even if the seller's strategy set is reduced to prices. Then we turn to the best-reply matching (BRM) approach developed by Droste, Kosfeld & Voorneveld (2003) for games in normal form. In a BRM equilibrium, the probability assigned by a player to a pure strategy is linked to the number of times this strategy is a best reply to the other players’ played strategies. We extend this logic to signaling games in extensive form and apply the new obtained concept to Akerlof’s model. This new concept leads to a very simple rule of behaviour, which is consistent, different from the Bayesian equilibrium behaviour, different from Akerlof’s result, and can be socially efficient.
    Keywords: best-reply matching, experience goods, signalling game, mixed Perfect Bayesian Equilibrium, extensive form, normal form.
    JEL: C72 D82 L15
    Date: 2007
  14. By: Besanko, David; Doraszelski, Ulrich; Kryukov, Yaroslav; Satterthwaite, Mark
    Abstract: Learning-by-doing and organizational forgetting have been shown to be important in a variety of industrial settings. This paper provides a general model of dynamic competition that accounts for these economic fundamentals and shows how they shape industry structure and dynamics. Previously obtained results regarding the dominance properties of firms' pricing behaviour no longer hold in this more general setting. We show that organizational forgetting does not simply negate learning-by-doing. Rather, learning-by-doing and organizational forgetting are distinct economic forces. In particular, a model with both learning-by-doing and organizational forgetting can give rise to aggressive pricing behaviour, market dominance, and multiple equilibria, whereas a model with learning-by-doing alone cannot.
    Keywords: dynamic games; learning-by-doing; organizational forgetting
    JEL: C73 D43
    Date: 2007–03
  15. By: Beatriz Tovar; Sergio Jara-Díaz; Lourdes Trujillo (Department of Economics, City University, London and DAEA, Universidad de Las Palmas de Gran Canaria)
    Abstract: Seaports provide multiple services to ships, cargo, and passengers. Size of the port and type of service are two key elements when deciding whether competition is feasible and how to promote it, or conversely regulation is needed. Analyzing this requires a profound knowledge of the cost structure of the activity involved. This means not only knowing total costs for different volumes of aggregated traffic, but also the behavior of costs when part of the bundle is produced, i.e. when the mix changes. The optimal organization of the industry can be studied by means of cost and production functions. This paper offers a review of the relatively scarce literature about econometric ports’ cost structure, and highlights the role of the multioutput approach as the correct one because allows the calculation of key cost indicators (economies of scale, scope, and so forth) to determine the optimal port industrial structure for a given forecast of demand (traffic mix and volume).
    Keywords: multiproduct, economies of scale and scope, port and cargo handling
    JEL: L9
    Date: 2007–02

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