nep-mic New Economics Papers
on Microeconomics
Issue of 2008‒11‒11
eleven papers chosen by
Joao Carlos Correia Leitao
Technical University of Lisbon

  1. Does the absence of competition in the market foster competition for the market? A dynamic approach to aftermarkets By LAUSSEL, Didier; RESENDE, Joana
  2. A Retail Benchmarking Approach to Efficient Two-Way Access Pricing: Termination-Based Price Discrimination with Elastic Subscription Demand By Sjaak Hurkens; Doh-Shin Jeon
  3. On investment decisions in liberalized electricity markets: the impact of price caps at the spot market By ZOETTL, Gregor
  4. Compatibility choice in vertically differentiated technologies By GARCIA, Filomena; VERGARI, Cecilia
  5. Investment decisions in liberalized electricity markets: A framework of peak load pricing with strategic firms By ZOETTL, Gregor
  6. Should R&D Champions be Protected from Foreign Takeovers? By Bertrand, Olivier; Nilsson Hakkala, Katariina; Norbäck, Pehr-Johan; Persson, Lars
  7. Uncertainty quality, product variety and price competition By GABSZEWICZ, Jean J.; RESENDE, Joana
  8. Mixed duopoly, privatization and the shadow cost of public funds By CAPUANO, Carlo; DE FEO, Giuseppe
  9. Efficiency gains and mergers By DE FEO, Giuseppe
  10. Incumbent Innovation and Entry by Spinoff By Oliver Falck; Stephan Heblich
  11. To acquire, or to compete? An entry dilemna By GABSZEWICZ, Jean; LAUSSEL, Didier; TAROLA, Ornella

  1. By: LAUSSEL, Didier; RESENDE, Joana (Université catholique de Louvain (UCL). Center for Operations Research and Econometrics (CORE))
    Abstract: In this paper, we investigate dynamic price competition when firms strategically interact in two distinct but interrelated markets: a primary market and an aftermarket, where indirect network effects arise. We set up a differential game of two-dimensional price competition and we conclude that the absence of price competition in the aftermarket (competition in the market) fosters dynamic price competition in the primary market (competition for the market). We also investigate the impact of network sizes on firms' prices in the primary market concluding that, in equilibrium, larger firms have incentives to compete more fiercely for new "uncolonized" consumers.
    Keywords: dynamic competition, differential games, Linear Markov Perfect Equilibrium, aftermarkets, network effects.
    JEL: C61 L11 L13
    Date: 2008–05
  2. By: Sjaak Hurkens (Institute for Economic Analysis (CSIC)); Doh-Shin Jeon (Department of Economics and Business, Universitat Pompeu Fabra)
    Abstract: We study how access pricing affects network competition when consumers' subscription demand is elastic and networks compete with non-linear prices and can use termination-based price discrimination. In the case of a fixed per minute termination charge, our model generalizes the results of Gans and King (2001), Dessein (2003) and Calzada and Valletti (2008). We show that a reduction of the termination charge below cost has two opposing effects: it softens competition and it helps to internalize network externalities. The former reduces consumer surplus while the latter increases it. Firms always prefer termination charge below cost, either to soften competition or to internalize the network effect. The regulator will favor termination below cost only when this boosts market penetration. Next, we consider the retail benchmarking approach (Jeon and Hurkens, 2008) that determines termination charges as a function of retail prices and show that this approach allows the regulator to increase subscription without distorting call volumes. Furthermore, we show that an informed regulator can even implement the first-best outcome by using this approach.
    Keywords: Networks, Access Pricing, Interconnection, Regulation, Telecommunications
    JEL: D4 K23 L51 L96
    Date: 2008–11
  3. By: ZOETTL, Gregor
    Abstract: We analyze the impact of a uniform price cap at electricity spot markets on firms investment decisions and on welfare. Since investment decisions for those markets are taken in the long run, fluctuating demand at the spot market eventually gives rise to high price spikes in case of binding capacities. Those price spikes are considered to send accurate signals for investment in generation capacities, limiting those spikes by price caps is thought to reduce firms' investment incentives. We are able to show that this is not true for the case of strategic investment behavior. More specifically we analyze a market game where firms choose capacities prior to a spot market which is subject to fluctuating or uncertain demand. We derive, that appropriately chosen price caps do always increase firms investment incentives under imperfect competition. We furthermore characterize the optimal price cap. Based on the theoretical framework, we empirically analyze the impact of uniform price caps on the German electricity market.
    Keywords: Investment incentives, price caps, fluctuating demand, electricity markets
    JEL: D43 L13 D41 D42 D81
    Date: 2008–06
  4. By: GARCIA, Filomena (ISEG, Technical University of Lisbon); VERGARI, Cecilia (Université catholique de Louvain (UCL). Center for Operations Research and Econometrics (CORE))
    Abstract: We analyse firms' incentives to provide two-way compatibility between two network goods with different intrinsic qualities. We study how the relative importance of vertical differentiation with respect to the network effect influences the price competition as well as the compatibility choice. The final degree of compatibility allows firms to manipulate the overall differentiation. Under weak network effect, full compatibility may arise: the low quality firm has higher incentives to offer it in order to prevent the rival from dominating the market. Under strong network effect we observe multiple equilibria for consumers' demands. However, in any equilibrium of the full game, coordination takes place on the high quality good which, we assume, always maintains its overall quality dominance.
    Keywords: compatibility, vertical differentiation, network effect.
    JEL: L13 L15
    Date: 2008–03
  5. By: ZOETTL, Gregor
    Abstract: In this article we analyze firms investment incentives in liberalized electricity markets. Since electricity is economically non storable, it is optimal for firms to invest in a differentiated portfolio of technologies in order to serve strongly fluctuating demand. Prior to the Liberalization of electricity markets, for regulated monopolists, optimal investment and pricing strategies haven been analyzed in the peak load pricing literature (compare Crew and Kleindorder (1986)). In restructured electricity markets regulated monopolistic generators have often been replaced by competing and potentially strategic firms. This article aims to respond to the changed reality and model investment decisions of strategic firms in those markets. We derive equilibrium investment for strategic firms and compare to the benchmark cases of perfect competition and monopoly outcomes. We find that strategic firms have an incentive to overinvest in base-load technologies but choose total capacities too low from a welfare point of view. By fitting the framework to a specific electricity market (Germany) we are able to empirically analyze Investment choices of strategic firms, and quantify the potential for market power and its impact on generation portfolios in restructured electricity markets in the long run.
    Keywords: Investment decisions, technology choice, restructured electricity markets, peak load pricing, strategic firms.
    Date: 2008–07
  6. By: Bertrand, Olivier (Graduate School of Management of St Petersburg State University and Toulouse School of Economics); Nilsson Hakkala, Katariina (Helsinki School of Economics and Government Institute for Economic Research (VATT)); Norbäck, Pehr-Johan (Research Institute of Industrial Economics (IFN)); Persson, Lars (Research Institute of Industrial Economics (IFN))
    Abstract: We analyze how the entry mode of Foreign Direct Investments (FDI) affects affiliate R&D activities. Using unique affiliate level data for Swedish multinational firms, we first present empirical evidence that acquired affiliates have a higher level of R&D intensity than greenfield (start-up) affiliates. This gap persists over time and with the age of the affiliates, as well as for different firm types and industries. To explain this finding, we develop an acquisition-investment-oligopoly model where we show that for a foreign acquisition to take place in equilibrium, the acquiring MNE must invest sufficiently in sequential R&D in the affiliate. Otherwise, rivals will expand their business, thus making the acquisition unprofitable. Two additional predictions of the model – that foreign firms acquire high-quality domestic firms and that the gap in R&D between acquired and greenfield affiliates decreases in acquisition transaction costs – are consistent with the data.
    Keywords: FDI; M&A; Multinational firms; R&D
    JEL: F23 L10 L20 O30
    Date: 2008–10–17
  7. By: GABSZEWICZ, Jean J. (Université catholique de Louvain (UCL). Center for Operations Research and Econometrics (CORE)); RESENDE, Joana
    Abstract: This paper analyses price competition under product differentiation when goods are defined in a two dimensional characteristic space, and consumers do not know which firm sells which quality. Equilibrium prices consist of two additive terms, which balance consumers' relative valuation of goods' expected quality and consumers' preferences for variety. However the relative importance of these terms differ under vertical and horizontal dominance.
    Keywords: product differentiation, variety, quality, uncertainty
    JEL: D43 D80 L15
    Date: 2008–06
  8. By: CAPUANO, Carlo (University of Naples Federico II); DE FEO, Giuseppe (Université catholique de Louvain (UCL). Center for Operations Research and Econometrics (CORE))
    Abstract: The purpose of this paper is to investigate the effect of privatization in a mixed duopoly, where a private firm competes in quantities with a welfare-maximizing public firm. We consider two inefficiencies of the public sector: a possible cost inefficiency, and an allocative inefficiency due to the distortionary effect of taxation (shadow cost of public funds). Furthermore, we analyze the effect of privatization on the timing of competition by endogenizing the determination of simultaneous (Nash-Cournot) versus sequential (Stackelberg) games using the model developed by Hamilton and Slutsky (1990). The latter is especially relevant for the analysis of privatization, given that results and policy prescription emerged in the literature crucially rely on the type of competition assumed. We show that privatization has generally the effect of shifting from Stackelberg to Cournot equilibrium and that, absent efficiency gains privatization never increases welfare. Moreover, even when large efficiency gains are realized, an inefficient public firm may be preferred.
    Keywords: mixed oligopoly, privatization, endogenous timing, distortionary taxes.
    JEL: H2 H42 L13 L32 L33
    Date: 2008–03
  9. By: DE FEO, Giuseppe (Université catholique de Louvain (UCL). Center for Operations Research and Econometrics (CORE))
    Abstract: In the theoretical literature, strong arguments have been provided in support of the efficiency defense in antitrust merger policy. One of the most often cited results is due to Williamson (1968) that shows how relatively small reduction in cost could offset the deadweight loss of a large price increase. Furthermore, Salant et al. (1983) demonstrate that (not for monopoly) mergers are unprofitable absent efficiency gains. The general result, drawn in a Cournot framework by Farrell and Shapiro (1990), is that (not too large) mergers that are profitable are always welfare improving. In the present work we challenge the conclusions of this literature in two aspects. First, we show that Williamson's results underestimate the welfare loss due to a price increase and overestimate the effect of efficiency gains. Then, we prove that the conditions for welfare improving mergers defined by Farrell and Shapiro (1990) hold true only when consumers are adversely affected. This seems an argument to disregard their policy prescriptions when antitrust authorities are more "consumers-oriented". In this respect, we provide a necessary and sufficient condition for a consumer surplus improving merger: in a two firm merger, efficiency gains must be larger than the pre-merger average markup.
    Keywords: mergers, efficiency gains, Cournot oligopoly.
    JEL: D43 L11 L22
    Date: 2008–01
  10. By: Oliver Falck (Ifo Institute for Economic Research, CESifo and Max Planck Institute of Economics, Jna, Germany); Stephan Heblich (Max Planck Institute of Economics, Jena, Germany)
    Abstract: This paper takes a different perspective toward the escape entry incentive of incumbent firms to innovate. New entrants spawned from incumbents are not necessarily a threat; they can complement incumbents' production by commercializing knowledge incumbents are not willing or able to exploit. Accordingly, incumbent innovation determines exploitable knowledge externalities for spinoffs while, at the same time, spinoffs are expected to influence incumbent innovation. To overcome this problem of endogeneity, we apply an IV approach to analyze a rich industry-level dataset (1987–2000) for Germany. We find evidence that entry by spinoffs does, indeed, have a positive impact on incumbent innovation.
    Keywords: Innovation, Entry, Spinoff
    JEL: O3 L16 M13
    Date: 2008–11–04
  11. By: GABSZEWICZ, Jean (Université catholique de Louvain (UCL). Center for Operations Research and Econometrics (CORE)); LAUSSEL, Didier; TAROLA, Ornella
    Abstract: In this paper we address the following question: is it more profitable, for an entrant in a differentiated market, to acquire an existing firm than to compete? We illustrate the answer by considering competition in the banking sector.
    Keywords: Vertical differentiation, entry, banking competition
    JEL: G34 L13 L22
    Date: 2008–05

This nep-mic issue is ©2008 by Joao Carlos Correia Leitao. It is provided as is without any express or implied warranty. It may be freely redistributed in whole or in part for any purpose. If distributed in part, please include this notice.
General information on the NEP project can be found at For comments please write to the director of NEP, Marco Novarese at <>. Put “NEP” in the subject, otherwise your mail may be rejected.
NEP’s infrastructure is sponsored by the School of Economics and Finance of Massey University in New Zealand.