nep-mic New Economics Papers
on Microeconomics
Issue of 2007‒11‒10
seventeen papers chosen by
Joao Carlos Correia Leitao
University of the Beira Interior

  1. Competition and Innovation: An Experimental Investigation By Dario Sacco
  2. Dynamic Advertising with Spillovers: Cartel vs Competitive Fringe By Luca Lambertini; Arsen Palestini
  3. On a foundation for Cournot equilibrium By Alex Dickson; Roger Hartley
  4. The Control of Porting in Two-Sided Markets By Pollock, R.
  5. Protecting the Domestic Market: Industrial Policy and Strategic Firm Behaviour By Jens Metge
  6. Understanding the Lack of Competition in Natural Gas Markets: The Impact of Storage Ownership and Upstream Competition By Michal Mravec
  7. International Competition in Vertically Differentiated Markets with Innovation and Imitation: Trade Policy versus Free Trade By Eugen Kovac; Kresimir Zigic
  8. Inflow Uncertainty in Hydropower Markets By Petter Vegard Hansen
  9. The relation between competition and innovation – Why is it such a mess? By Armin Schmutzler
  10. Probalilistic duopoly with differentiation by attributes By Reynald-Alexandre Laurent
  11. Standards Competition In The Presence Of Digital Conversion Technology: An Empirical Analysis Of The Flash Memory Card Market By Charles Z. Liu; Chris F. Kemerer; Michael D. Smith
  12. Search Engine Advertising: Pricing Ads to Context By Avi Goldfarb; Catherine Tucker;
  13. Escalation Game with Endogenous Demands and The Nash Bargaining Solution By Helena Hye-Young Kim; Frand Spinnewyn
  14. Gradual Revelation Mechanism with Two-Sided Screening By Helena Hye-Young Kim; Frans Spinnewyn; Luc Lauwers
  15. Water Demand Under Alternative Price Structures By Sheila Olmstead; W. Michael Hanemann; Robert N. Stavins
  16. Firms' Differential Innovative Success and Market Dynamics By Uwe Cantner
  17. Advertising and production of a seasonal good for a heterogeneous market: from total segment separability to real media By Daniela Favaretto; Bruno Viscolani

  1. By: Dario Sacco (Socioeconomic Institute, University of Zurich)
    Abstract: The paper analyzes the effects of competitive intensity on firms' incentives to invest in process innovations through an experiment based on two-stage games, where R&D investment choices are followed by product market competition. An increase in the intensity of competition is modeled as an increase in the number of Þrms or as a switch from Cournot to Bertrand. The theoretical prediction is that more intense competition is unfavorable to investments for both cases. In the experiment it turns out that the way of modeling the intensity of competition is essential. The theoretical prediction is confirmed for the number effects. On the other hand, the comparison of Cournot and Bertrand shows that more intense competition is beneÞcial for investments.
    Keywords: R&D investment, intensity of competition, experiment
    JEL: C92 L13 O31
    Date: 2007–10
  2. By: Luca Lambertini (University of Bologna and The Rimini Centre for Economics Analysis, Italy.); Arsen Palestini (University of Bologna, Italy)
    Abstract: A differential oligopoly game with advertising is investigated, where different dynamics occur between two groups of agents, the former playing a competitive Nash game and the latter cooperating as a cartel. Sufficient conditions for stability and a qualitative analysis of the profit ratio and social welfare at equilibrium are provided. A threshold value for the size of the competitive fringe is pointed out by a suitable numerical simulation.
    Keywords: Advertising, Differential games, Oligopoly, Collusion
    JEL: C73 D43 D92 L13 M37
    Date: 2007–07
  3. By: Alex Dickson (Keele University, Centre for Economic Research and School of Economic and Management Studies); Roger Hartley (Department of Economics, University of Manchester)
    Abstract: We show in the context of a bilateral oligopoly where all agents are allowed to behave strategically the unexpected result that when the number of buyers becomes large the outcomes in a strategic market game do not converge to those at the Cournot equilibrium. However, convergence to Cournot outcomes is restored if the game is sequential: sellers move simultaneously as do buyers, but the former always move before the latter. This suggests that the ability to commit to supply decisions is an essential feature of Cournot equilibrium.
    Keywords: Cournot competition, strategic market game, strategic foundation.
    JEL: C72 D43 D51 L13
    Date: 2007–10
  4. By: Pollock, R.
    Abstract: A sizable literature has grown up in recent years focusing on two-sided markets in which economies of scale combined with complementarities between a platform and its associated ‘software’ or ‘services’ can generate indirect network effects (that is positive feedback between the number of consumers using that platform and the utility of an individual consumer). In this paper we introduce a model of ‘porting’ in such markets where porting denotes the conversion of ‘software’ or ‘services’ developed for one platform to run on another. Focusing on the case where a dominant platform exists we investigate the impact on equilibrium and the consequences for welfare of the ability to control porting. Specifically, we show that the welfare costs associated with the ‘control of porting’ may be more significant than those arising from pricing alone. This model and its associated results are of particular relevance because of the light they shed on debates about the motivations and effects of actions by a dominant platform owner. Recent examples of such debates include those about Microsoft’s behaviour both in relation to its operating system and its media player, Apple’s behaviour in relation to its DRM and iTunes platform, and Ebay’s use of the cyber-trespass doctrine to prevent access to its site. Key words: Network Effects, Two-Sided Markets, Porting, Antitrust, Competition.
    JEL: L15 L12 L13
    Date: 2007–11
  5. By: Jens Metge
    Abstract: Foreign firms to break into a new market commonly undercut domestic prices and, hence, subsidise the consumer's costs of switching in order to get a positive market share. However, this may constitute the act of dumping as drawn in Article VI of the General Agreement on Tariffs and Trade (GATT). Consequently, domestic firms trying to protect themselves against potential competitors often demand an anti-dumping (AD) investigation. In a two-period model of market entry with horizontally differentiated products and exogenous switching costs, it is demonstrated that the mere existence of switching costs and AD-rules may result in an anti-competition effect: the administratively set minimum-price rule protects the domestic firm and yields larger prices. Therefore, there are some consumers who will not buy either product in both periods although they would have done so in absence of AD. Consequently, competition policy should reassess the AD-regulation.
    Keywords: Industrial Policy; Anti-Dumping; Hotelling; Switching Costs; Market Entry
    Date: 2007–10
  6. By: Michal Mravec
    Abstract: Motivated by the failure of competition to emerge after the natural gas market in the Czech Republic was liberalized, I explore the impact of natural gas storage ownership and upstream competition on the downstream level. I extend standard Cournot models to understand current and likely future developments, paying particular attention to the impact of market liberalization on a country characterized by a lack of domestic production, limited foreign upstream competition, and highly concentrated (and bundled) control over an essential input in the production of the final product: gas storage. I show that the upstream producer may practice his market power to capture some of the benefits of liberalization and increase the wholesale price, which hinders the desired decline of the end-user price in the long run. This pricing change in turn makes the entry of new players in the transition period more difficult. I furthermore analyze three prominent storage structure scenarios and conclude that higher consumer welfare can be reached only in the case of regulated storage access.
    Keywords: Natural gas, liberalization, deregulation, successive oligopoly, monopoly, Czech Republic, gas storage.
    JEL: D42 D43 L11 L12 L13 L51
    Date: 2007–09
  7. By: Eugen Kovac; Kresimir Zigic
    Abstract: The important characteristic of international competition between developed and less developed countries is vertical product differentiation, where firms' quality choices represent strategic decisions. Unlike the previous literature, we allow for a leadership in quality choice and the possibility of imitation and learning by the domestic firm. We compare both positive and normative aspects of this setup in the free trade and the strategic trade policy regime and show that the value of leadership may change dramatically when moving from free trade to trade policy. We also identify conditions under which trade policy can initiate the change in the quality ladders (known as quality reversal) and demonstrate that such a policy has a somewhat limited scope to achieve it. Thus, free trade can still be an optimal trade arrangement.
    Keywords: Vertical differentiation, free trade, strategic trade policy, quality rever-sal, leadership, imitation.
    JEL: D43 F12 F13 L13
    Date: 2007–08
  8. By: Petter Vegard Hansen (Statistics Norway)
    Abstract: In order to analyse the consequences of uncertainty for prices and efficiency in a hydropower system, we apply a two-period model with uncertainty in water inflow. We study three different market structures, perfect competition, monopoly and oligopoly and stress the importance of the shape of the demand function under different distributions of water inflow. The uncertainty element creates possibilities of exercising market power depending on the distribution of uncertainty among producers. The introduction of thermal power into the hydropower market has an impact on the residual demand function, which is important for the hydropower producers' possibilities of exercising market power.
    Keywords: hydropower; uncertainty; electricity; thermal power; demand functions; monopoly; duopoly
    JEL: D40 Q11 Q41 L10
    Date: 2007–10
  9. By: Armin Schmutzler (Socioeconomic Institute, University of Zurich)
    Abstract: Using several simple examples, this paper shows that the effects of increasing competition on cost-reducing investments can be positive, negative or non-monotone. Also, competition is more likely to increase the investments of leaders than of laggards. To explain these findings, I use a reduced-form model. I identify four different transmission channels by which competition affects investments. Competition typically (i) reduces markups, but (ii) increases the sensitivity of equilibrium demand to marginal costs — this already implies countervailing effects on investment incentives. These difficulties are compounded because competition has ambiguous effects on (iii) the level of equilibrium demand and (iv) the extent to which efficiency gains are passed through to consumers as lower prices. Because of these ambiguities, there is not much hope of establishing a robust relation between competition and investment.
    Keywords: competition, investment, cost reduction
    JEL: L13 L20 L22
    Date: 2007–11
  10. By: Reynald-Alexandre Laurent
    Abstract: This paper proposes a discrete choice duopoly in which products are described and differentiated by their specific attributes. These attributes can be discrete characteristics or differences in continuous variables, such as prices or qualities. Consumers follow a probabilistic reasoning which is consistent with random decision rule models such as Tversky's "Elimination by Aspects" framework (1972a,b). This type of behavior is relevant for small everyday life purchases. The demand system provides a general structure of product differentiation in which special cases are given by classical models of horizontal and vertical differentiation. Existence and uniqueness of a price Nash equilibrium in pure strategies are established in the duopoly. When attributes' utilities vary, comparative statics properties of profits can be explained by "attractiveness" and "differentiation" effects. These effects are combined in a new way compared to the deterministic structures or to the logit duopoly. For example, an increase in the low utility index of attributes strengthens product differentiation.
    Date: 2007
  11. By: Charles Z. Liu (Katz Graduate School of Business, University of Pittsburgh); Chris F. Kemerer (Katz Graduate School of Business, University of Pittsburgh); Michael D. Smith (Heinz School of Public Policy and Management, Carnegie Mellon University)
    Abstract: Both theoretical and empirical evidence suggest that in markets with standards competition, strong network effects can make the strong grow stronger and, in some circumstances, even “tip” the market towards a single, winner-take-all standard. We theorize that in the presence of low cost conversion technologies and digital content, the tendency towards market dominance can be lessened to the point where multiple incompatible standards are viable. Our hypotheses are empirically examined in the context of the flash memory card market where both network effects and high quality conversion are present. The results show that the availability of digital converters reduces the price premium of the leading flash card formats more than of the minority formats. Therefore, producers of the non-dominant standards can be better off with the provision of conversion technology as this technology neutralizes the impact of network effects that would have otherwise been more potent. We discuss both the social and private implications of our findings.
    Keywords: network effects, standards competition, conversion technologies, flash memory, digital goods
    JEL: C12 C23 D62 L11 L15
    Date: 2007–09
  12. By: Avi Goldfarb (Rotman School of Management, University of Toronto); Catherine Tucker (Sloan School of Management, MIT);
    Abstract: Each search term put into a search engine produces a separate set of results. Correspondingly, each of the sets of ads displayed alongside these results is priced using a separate auction. Search engine advertising prices therefore reflect willingness to pay for context, unlike traditional ad prices that reflect willingness to pay for audience demographics. A growing policy debate asks if this marketing strategy merely makes advertising more informative, or whether it also effectively extracts rent from advertisers. To inform this debate and to better understand search engine advertising more generally, we examine advertising prices paid by lawyers for 174 Google search terms in 195 locations and exploit a natural experiment in “ambulance-chaser” regulations across states. Where contingency fee limits exist, the relative price of advertising is $2.27 lower. This suggests that context-based pricing allows prices to reflect heterogeneity in the profitability of customer leads. When lawyers cannot contact a client in writing, the relative price per ad click is $0.93 higher. This suggests that context-based pricing allows prices to reflect heterogeneity in advertisers’ other advertising options, even within a given local market. Thus, our results suggest that search engine advertising does give market power to the media platform; however, this market power is mitigated by substantial competition from offline marketing communications channels.
    Keywords: search engines, advertising, market power, advertising prices
    JEL: L86 M37
    Date: 2007–09
  13. By: Helena Hye-Young Kim (Department of Economics, Korea University); Frand Spinnewyn (Department of Economic, K.U.Leuven)
    Abstract: The paper examines the behavior of two agents who need to make a joint decision but they have conflicting preferences about the choice of the outcome. Conventionally such problem is considered as the bargaining problem described as the situation of dividing a pie. But we introduce the model that sheds a different light on the problem in question. The problem is described as the conflict situation modelled as a two-stage game. In the first stage players propose outcomes. The settlement is made if the proposed outcomes are the same. If not, the game moves onto the second stage where they play the concession game called the escalation game. In the escalation game, each player, in turn, has the choice between either to submit by accepting the other’s demand or to escalate by way of insisting his demand to be accepted. Each escalation generates a probability of an inefficient outcome. There are two main findings: (1) it is shown that the player’s decision is determined by his risk limit which measures his intensity towards winning. (2) if the escalation game allocates the demand of the player with the highest risk limit, then players propose the Nash cooperative solution.
    Keywords: Bargaining, Risk Limit, Nash Bargaining Solution
    JEL: C72 C78
    Date: 2007
  14. By: Helena Hye-Young Kim (Department of Economics, Korea University); Frans Spinnewyn (Department of Economic, K.U.Leuven); Luc Lauwers (Department of Economic, K.U.Leuven)
    Abstract: We investigate the mechanism that provides the optimal decision rule for two agents making joint decisions. It is shown that, a special rectangular mechanism with two sided screening, elicit correct information when agents?preferences are private information. Such mechanism is presented as a game of incomplete information. It is shown that if types are uniformly distributed, then a three stage sequential game with an exogenously given probability of a terminal break down cannot be improved upon within a restricted class of models.
    Keywords: Mechanism Design, Efficiency, Risk Limit
    Date: 2007
  15. By: Sheila Olmstead; W. Michael Hanemann; Robert N. Stavins
    Abstract: We estimate the price elasticity of water demand with household-level data, structurally modeling the piecewise-linear budget constraints imposed by increasing-block pricing. We develop a mathematical expression for the unconditional price elasticity of demand under increasing-block prices and compare conditional and unconditional elasticities analytically and empirically. We test the hypothesis that price elasticity may depend on price structure, beyond technical differences in elasticity concepts. Due to the possibility of endogenous utility price structure choice, observed differences in elasticity across price structures may be due either to a behavioral response to price structure, or to underlying heterogeneity among water utility service areas.
    JEL: D12 L95 Q21 Q25 Q28
    Date: 2007–11
  16. By: Uwe Cantner (Friedrich Schiller University Jena, Faculty of Economics and Business Administration)
    Abstract: This paper deals with innovative activities of firms, the resulting market success as well as the interdependencies between both. In a first theoretical part, different cases of those interdependencies are investigated by the way of a simple model based on replicator dynamics. It is shown that the resulting differential success (in those activities) of firms in a market leads to specific characteristic pattern of industry dynamics. The second empirical part of the paper is used to get an account of the working of replicator dynamics mechanism within German manufacturing. Doing so changes in firms' market shares and the relation to their respective relative technological performance and to their or innovative performance are investigated with productivity levels as a proxy for technological performance and productivity changes as proxy for innovative performance.
    Keywords: Innovation, market competition, replicator dynamics, productivity decomposition
    JEL: O3 L1 D24
    Date: 2007–11–01
  17. By: Daniela Favaretto (Department of Applied Mathematics, University of Venice); Bruno Viscolani (Dept. of Pure and Applied Mathematics, University of Padua)
    Abstract: Market segmentation is a fundamental topic of marketing theory and practice. We bring some market segmentation concepts into the statement of an advertising and production problem for a seasonal product with Nerlove-Arrow's linear goodwill dynamics, along the lines of some analyses concerning the introduction of a new product. We consider two kinds of situations. In the first one, we assume that the advertising process can reach selectively each segment. In the second one, we assume that one advertising medium is available and that it has a known effectiveness segment-spectrum for a non-trivial set of segments. In both cases we study the optimal control problems in which goodwill productivity of advertising is either linear or concave, and good production costs are (convex and) quadratic. We obtain the explicit optimal solutions using the Pontryagin's Maximum Principle conditions.
    JEL: M37 M31 C61
    Date: 2007–10

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