nep-mic New Economics Papers
on Microeconomics
Issue of 2009‒09‒26
seventeen papers chosen by
Vaishnavi Srivathsan
Indian Institute of Technology

  1. Mixed Source By Ramon Casadesus-Masanell; Gaston Llanes
  2. Price Competition and Consumer Confusion By Chioveanu, Ioana; Zhou, Jidong
  3. Raising capital in an insurance oligopoly market By Julien Hardelin; Sabine Lemoyne De Forges
  4. Dynamic Competition with Consumer Inertia By Pot Erik; Flesch János; Peeters Ronald; Vermeulen Dries
  5. Quantity-setting games with a dominant firm By Attila Tasnádi
  6. A Computational View of Market Efficiency By Jasmina Hasanhodzic; Andrew W. Lo; Emanuele Viola
  7. A Dynamic Model of Lawsuit Joinder and Settlement By Andrew F. Daughety; Jennifer F. Reinganum
  8. Oligopolistic Competition and Optimal Monetary Policy By Ester Faia
  9. Incomplete Contracts, Irreversible Investments and Entry Deterrence By Antonio Nicita; Massimiliano Vatiero
  10. Financial Innovation and Endogenous Growth By Stelios Michalopoulos; Luc Laeven; Ross Levine
  11. First We Try, Then We Trust! Real Options and the Cooperation-Competition Tension in Strategic Alliance Social Dilemmas By McCarter, Matthew W.; Mahoney, Joseph T.; Northcraft, Gregory B.
  12. Strategies to Fight Ad-sponsored Rivals By Ramon Casadesus-Masanell; Feng Zhu
  13. Behavioural and Dynamical Scenarios for Contingent Claims Valuation in Incomplete Markets By Lampros Boukas; Diogo Pinheiro; Alberto Pinto; Stylianos Xanthopoulos; Athanasios Yannacopoulos
  14. The scale of market quakes By T. Bisig; A. Dupuis; V. Impagliazzo; R. B. Olsen
  15. The evolution of an industrial cluster in China: By Fleisher, Belton; Hu, Dinghuan; McGuire, William; Zhang, Xiaobo
  16. Public Provision of Private Goods and Nondistortionary Marginal Tax Rates: Some Further Results By Blomquist, Sören
  17. Adversarial versus Inquisitorial Testimony By Winand Emons; Claude Fluet

  1. By: Ramon Casadesus-Masanell (Harvard Business School, Harvard University); Gaston Llanes (Harvard Business School, Harvard University)
    Abstract: We study competitive interaction between profit-maximizing firms that sell software and complementary goods or services. In addition to tactical price competition, we allow firms to compete through business model reconfigurations. We consider three business models: the proprietary model (where all software modules offered by the firm are proprietary), the open source model (where all modules are open source), and the mixed source model (where a few modules are open). When a firm opens one of its modules, users can access and improve the source code. At the same time, however, opening a module sets up an open source (free) competitor. This hampers the firm's ability to capture value. We analyze three competitive situations: monopoly, commercial firm vs. non-profit open source project, and duopoly. We show that: (i) firms may become "more closed" in response to competition from an outside open source project; (ii) firms are more likely to open substitute, rather than complementary, modules to existing open source projects; (iii) when the products of two competing firms are similar in quality, firms differentiate through choosing different business models; and (iv) low-quality firms are generally more prone to opening some of their technologies than firms with high-quality products.
    Keywords: Open Source, User Innovation, Business Models, Complementarity, Vertical Differentiation, Value Creation, Value Capture
    JEL: O31 L17 D43
    Date: 2009–09
  2. By: Chioveanu, Ioana; Zhou, Jidong
    Abstract: This paper proposes a model in which identical sellers of a homogenous product compete in both prices and price frames (i.e., ways to present price information). We model price framing by assuming that firms’ frame choices affect the comparability of their price offers: consumers may fail to compare prices due to frame differentiation, and due to frame complexity. In the symmetric equilibrium the firms randomize over both price frames and prices, and make positive profits. This result is consistent with the observed coexistence of price and price frame dispersion in the market. We also show that (i) the nature of equilibrium depends on which source of consumer confusion dominates, and (ii) an increase in the number of firms can increase industry profits and harm consumers.
    Keywords: bounded rationality; framing; frame dispersion; incomplete preferences; price competition; price dispersion
    JEL: L13 D43
    Date: 2009–09–01
  3. By: Julien Hardelin (Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X, AgroParisTech ENGREF - (-)); Sabine Lemoyne De Forges (Department of Economics, Ecole Polytechnique - CNRS : UMR7176 - Polytechnique - X, AgroParisTech ENGREF - (-))
    Abstract: We consider an oligopoly of firms that compete on price. Firms produce a non-stochastic output, insurance coverage, which is sold before the true cost is known. They behave as if they were risk-averse for a standard reason of costly external finance. The model consists in a two-stage game. At stage 1, each firm chooses its internal capital level. At stage 2, firms compete on price. We characterize the conditions for Nash equilibria and analyze the strategic impact of capital choice on the market. We discuss the model with regard to insurance industry specificity and regulation.
    Keywords: Price Competition; Risk-averse Firms; Insurance Market; Capital Choice.
    Date: 2009–09–16
  4. By: Pot Erik; Flesch János; Peeters Ronald; Vermeulen Dries (METEOR)
    Abstract: We study a framework where two duopolists compete repeatedly in prices and where cho-sen prices potentially affect future market shares, but certainly do not affect current sales.This assumption of consumer inertia causes (noncooperative) coordination on high pricesonly to be possible as an equilibrium for low values of the discount factor. In particular,high discount factors increase opportunism and aggressiveness of competition to such anextent that high prices are no longer sustainable as an equilibrium outcome (not even intrigger strategies). In addition, we find that both monopolization and enduring marketshare and price fluctuations (price wars) can be equilibrium path phenomena withoutrequiring exogenous shocks in market or firm characteristics.
    Keywords: microeconomics ;
    Date: 2009
  5. By: Attila Tasnádi
    Abstract: We consider a possible game-theoretic foundation of Forchheimer’s model of dominant-firm price leadership based on quantity-setting games with one large firm and many small firms. If the large firm is the exogenously given first mover, we obtain Forchheimer’s model. We also investigate whether the large firm can emerge as a first mover of a timing game. Keywords
    Keywords: Forchheimer; Dominant firm; Price leadership.
    JEL: D43 L13
    Date: 2009–09–25
  6. By: Jasmina Hasanhodzic; Andrew W. Lo; Emanuele Viola
    Abstract: We propose to study market efficiency from a computational viewpoint. Borrowing from theoretical computer science, we define a market to be \emph{efficient with respect to resources $S$} (e.g., time, memory) if no strategy using resources $S$ can make a profit. As a first step, we consider memory-$m$ strategies whose action at time $t$ depends only on the $m$ previous observations at times $t-m,...,t-1$. We introduce and study a simple model of market evolution, where strategies impact the market by their decision to buy or sell. We show that the effect of optimal strategies using memory $m$ can lead to "market conditions" that were not present initially, such as (1) market bubbles and (2) the possibility for a strategy using memory $m' > m$ to make a bigger profit than was initially possible. We suggest ours as a framework to rationalize the technological arms race of quantitative trading firms.
    Date: 2009–08
  7. By: Andrew F. Daughety (Department of Economics, Vanderbilt University); Jennifer F. Reinganum (Department of Economics, Vanderbilt University)
    Abstract: In this paper we examine a dynamic model of the process by which multiple related lawsuits may be filed and combined; we also examine actions a defendant may employ that may disrupt the formation of a joint suit. Our initial model involves two potential plaintiffs, with private information about the harm they have suffered, in a multi-period setting with positive costs of filing a suit. If two plaintiffs file, they join their suits to obtain a lower per-plaintiff trial cost and a higher likelihood of prevailing against the defendant. We find that some plaintiff types never file, some wait to see if another victim files and only then file, some file early and then drop their suits if not joined by another victim and, finally, some file and pursue their suits whether or not they are joined; thus, the equilibrium resembles a Òbandwagon.Ó We then consider the effect of allowing preemptive settlement offers by the defendant aimed at discouraging follow-on suits. Preemptive settlement results in a Ògold rushÓ of cases into the first period. In general, plaintiffs (ex ante) strictly prefer that such preemptive settlements not be allowed, and computational results suggest this may be broadly true for defendants as well; however, the inability of defendants to commit to such a policy results in an equilibrium with preemptive settlement. Finally, we consider partial unawareness of victims as to the source of harm; this provides a role for plaintiffs' attorneys, who may seek additional victims to join a combined lawsuit. Confidential preemptive settlements in the case of partial unawareness restrict the plaintiff's attorney from seeking additional victims and therefore leads to higher preemptive settlement amounts. Moreover, the defendant strictly prefers to employ preemptive settlement if the fraction of unaware victims is sufficiently high.
    Keywords: Lawsuits, settlement, aggregation, dynamics
    JEL: K41 D82
    Date: 2009–09
  8. By: Ester Faia
    Abstract: The literature has shown that product market frictions and firms dynamic play a crucial role in reconciling standard DSGE with several stylized facts. This paper studies optimal monetary policy in a DSGE model with sticky prices and oligopolistic competition. In this model firms’ monopolistic rents induce both intra-temporal and intertemporal time-varying wedges which induce inefficient fluctuations of employment and consumption. The monetary authority faces a trade-off between stabilizing inflation and reducing inefficient fluctuations, which is resolved by using consumer price inflation as a state contingent sale subsidy. An analysis of the welfare gains of alternative rules show that targeting mark-ups and asset prices might improve upon a strict inflation targeting
    Keywords: product market frictions, oligopolistic competition, optimal monetary policy
    JEL: E3 E5
    Date: 2009–09
  9. By: Antonio Nicita; Massimiliano Vatiero
    Abstract: When renegotiation under incomplete contracts follows the outside option principle, hold-up may occur as the ex-post degree of competition increases on investor’s side. However, under this framework, asset specificity may play the counterintuitive role of an entry deterrence device, thus decreasing the probability of hold-up. Our result contrasts with standard literature in three respects: i) an equilibrium with overinvestment may emerge; ii) the 'intimidating effect' of overinvestment acts as an endogenous enforcement device; iii) a pervasive trade-off may emerge between ex-post efficient entry and ex-ante efficient specific investments
    Keywords: strategic and specific investments, hold-up, outside options, entry deterrence
    JEL: D23 D85 L14
    Date: 2009–08
  10. By: Stelios Michalopoulos; Luc Laeven; Ross Levine
    Abstract: We model technological and financial innovation as reflecting the decisions of profit maximizing agents and explore the implications for economic growth. We start with a Schumpeterian endogenous growth model where entrepreneurs earn monopoly profits by inventing better goods and financiers arise to screen entrepreneurs. A novel feature of the model is that financiers also engage in the costly, risky, and potentially profitable process of innovation: Financiers can invent more effective processes for screening entrepreneurs. Every existing screening process, however, becomes less effective as technology advances. Consequently, technological innovation and, thus, economic growth stop unless financiers continually innovate. Historical observations and empirical evidence are more consistent with this dynamic model of financial innovation and endogenous growth than with existing models of financial development and growth.
    JEL: G0 G3 O1 O31 O4
    Date: 2009–09
  11. By: McCarter, Matthew W. (University of Illinois at Urbana-Champaign); Mahoney, Joseph T. (University of Illinois at Urbana-Champaign); Northcraft, Gregory B. (University of Illinois at Urbana-Champaign)
    Abstract: The cooperation-competition tension in strategic alliances creates a social dilemma where
    Abstract: member and alliance interests are in conflict. Because social dilemmas have significant
    Abstract: negative implications for strategic alliance and member success, understanding the
    Abstract: psychological mechanisms underpinning the cooperation-competition tension and ways to
    Abstract: navigate this tension holds important theoretical implications for strategic alliance research.
    Abstract: This paper proposes a real options approach to navigating strategic alliance social dilemmas.
    Abstract: Acquiring a real option at the alliance level provides alliance members access to achieving a
    Abstract: small win of mutual cooperation, and, when the small win is realized, members are more
    Abstract: likely to cooperate in the larger strategic alliance. The increase of cooperation is because
    Abstract: alliance member's perceived vulnerability is reduced. The level of exposure when acquiring
    Abstract: the real option may influence the effect of a small win on perceived vulnerability through the
    Abstract: development of trust.
    Date: 2009–01
  12. By: Ramon Casadesus-Masanell (Strategy Unit, Harvard Business School); Feng Zhu (Management and Organization, Marshall School of Business, University of Southern California)
    Abstract: We analyze the optimal strategy of a high-quality incumbent that faces a low-quality ad-sponsored competitor. In addition to competing through adjustments of tactical variables such as price or advertising intensity, we allow the incumbent to consider changes in its business model. We consider four alternative business models, two pure models (subscription-based and ad-sponsored) and two mixed models that are hybrids of the two pure models. We show that the optimal response to an ad-sponsored rival often entails business model reconfigurations, a phenomenon that we dub "competing through business models." We also find that when there is an ad-sponsored entrant, the incumbent is more likely to prefer to compete through a pure, rather than a mixed, business model because of cannibalization and endogenous vertical differentiation concerns. We discuss how our study helps improve our understanding of notions of strategy, business model, and tactics in the field of strategy.
    Keywords: Strategy, Business models, Tactics, Ad-sponsored, Subscription-based
    JEL: L12 L13 M21
    Date: 2009–09
  13. By: Lampros Boukas; Diogo Pinheiro; Alberto Pinto; Stylianos Xanthopoulos; Athanasios Yannacopoulos
    Abstract: We study the problem of determination of asset prices in an incomplete market proposing three different but related scenarios. One scenario uses a market game approach whereas the other two are based on risk sharing or regret minimizing considerations. Dynamical schemes modeling the convergence of the buyer's and of the seller's prices to a unique price are proposed.
    Date: 2009–03
  14. By: T. Bisig; A. Dupuis; V. Impagliazzo; R. B. Olsen
    Abstract: We define a methodology to quantify market activity on a 24 hour basis by defining a scale, the so-called scale of market quakes (SMQ). The SMQ is designed within a framework where we analyse the dynamics of excess price moves from one directional change of price to the next. We use the SMQ to quantify the FX market and evaluate the performance of the proposed methodology at major news announcements. The evolution of SMQ magnitudes from 2003 to 2009 is analysed across major currency pairs.
    Date: 2009–09
  15. By: Fleisher, Belton; Hu, Dinghuan; McGuire, William; Zhang, Xiaobo
    Abstract: "We use two rounds of surveys, taken in 2000 and 2008 in the Zhili Township children's garment cluster in Zhejiang Province, to examine in depth the evolution of this industrial cluster. Firm size has grown on average in terms of output and employment, and increasing divergence in firm sizes has been associated with a significant rise in specialization and outsourcing among firms in the cluster. Although the investment amount needed to start a business has more than tripled, this amount remains low enough that formal bank loans remain an insignificant source of finance. Because of low entry barriers, the number of firms in the cluster has risen, driving down profits and bidding up wages, particularly since the year 2000. Facing severe competition, more firms have begun to upgrade their product quality. By the year 2007, nearly half of the sampled firms had established registered trademarks and nearly 20 percent had become International Office of Standardization (ISO) certified." from authors' abstract
    Keywords: Cluster, Industrialization, Growth, Development strategies,
    Date: 2009
  16. By: Blomquist, Sören (Department of Economics)
    Abstract: The incidence and efficiency losses of taxes have usually been analyzed in isolation from public expenditures. This negligence of the expenditure side may imply a serious misperception of the effects of marginal tax rates. The reason is that part of the marginal tax may in fact be a payment for publicly provided goods and reflects a cost that the consumers should bear in order to face the proper incentives. Hence, part of the marginal tax may serve the same role as a market price in the sense that it conveys information about a real social cost of working more hours. <p> We develop this idea formally by studying an optimal income tax model in combination with a type of public provision scheme not analyzed before; the provision level is individualized and positively associated with the individual’s labor supply. As examples we discuss child care, elderly care, primary education and health care. We show that there is a potential gain in efficiency where public provision of such services replaces market purchases. We also show that it is necessary for efficiency that, other things equal, marginal income tax rates are higher than in economies where the services are purchased in the market. This because the optimal tax should be designed so as to face the taxpayers with the real cost of providing the services. Hence, it might very well be that economies with higher marginal tax rates have less severe distortions than economies with lower marginal tax rates.
    Keywords: Nonlinear income taxation; Marginal income tax rates; Public provision of private goods; In-kind transfers
    JEL: H21 H42 I38
    Date: 2009–09–18
  17. By: Winand Emons; Claude Fluet
    Abstract: An arbiter can decide a case on the basis of his priors, or the two parties to the conflict may present further evidence. The parties may misrepresent evidence in their favor at a cost. At equilibrium the two parties never testify together. When the evidence is much in favor of one party, this party testifies. When the evidence is close to the prior mean, no party testifies. We compare this outcome under a purely adversarial procedure with the outcome under a purely inquisitorial procedure (Emons and Fluet 2009). We provide sufficient conditions on when one procedure is better than the other one.
    Keywords: evidence production; procedure; costly state falsification; adversarial; inquisitorial
    JEL: D82 K41 K42
    Date: 2009–09

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