nep-mic New Economics Papers
on Microeconomics
Issue of 2011‒11‒01
fourteen papers chosen by
Jing-Yuan Chiou
IMT Lucca Institute for Advanced Studies

  1. Optimism and Pessimism with Expected Utility By David Dillenberger; Andrew Postlewaite; Kareen Rozen
  2. Robust Predictions in Games with Incomplete Information By Dirk Bergemann; Stephen Morris
  3. Optimal decision under ambiguity for diffusion processes By S\"oren Christensen
  4. One Step at a Time: Does Gradualism Build Coordination? By Sam Asher; Lorenzo Casaburi; Plamen Nikolov
  5. Utilitarianism or Welfarism: Does it Make a Difference? By Nicolas Gravel; Patrick Moyes
  6. On Risk Aversion, Classical Demand Theory, and KM Preferences By Leonard J. Mirman; Marc Santugini
  7. Gradual Negotiations and Proportional Solutions By Rachmilevitch, Shiran
  8. Endogenous Bid Rotation in Repeated Auctions By Rachmilevitch, Shiran
  9. Fairness, Efficiency, and the Nash Bargaining Solution By Rachmilevitch, Shiran
  10. Newcomb's Paradox: a Subversive Interpretation By K.Vela Velupillai
  11. Unambiguous events and dynamic Choquet preferences. By Dominiak, Adam; Lefort, Jean-Philippe
  12. Moral hazard and lack of commitment in dynamic economies By Alexander K. Karaivanov; Fernando M. Martin
  13. Dynamic optimal insurance and lack of commitment By Alexander K. Karaivanov; Fernando M. Martin
  14. Inattention to Rare Events By Mackowiak, Bartosz Adam; Wiederholt, Mirko

  1. By: David Dillenberger (Dept. of Economics, University of Pennsylvania); Andrew Postlewaite (Dept. of Economics, University of Pennsylvania); Kareen Rozen (Cowles Foundation, Yale University)
    Abstract: Savage (1954) provided a set of axioms on preferences over acts that were equivalent to the existence of an expected utility representation. We show that in addition to this representation, there is a continuum of other "expected utility" representations in which for any act, the probability distribution over states depends on the corresponding outcomes. We suggest that optimism and pessimism can be captured by the stake-dependent probabilities in these alternative representations; e.g., for a pessimist, the probability of every outcome except the worst is distorted down from the Savage probability. Extending the DM's preferences to be defined on both subjective acts and objective lotteries, we show how one may distinguish optimists from pessimists and separate attitude towards uncertainty from curvature of the utility function over monetary prizes.
    Keywords: Subjective expected utility, Optimism, Pessimism, Stake-dependent probability
    JEL: D80 D81
    Date: 2011–10
  2. By: Dirk Bergemann; Stephen Morris
    Date: 2011–10–20
  3. By: S\"oren Christensen
    Abstract: In this paper we consider stochastic optimization problems for a risk-avers investor when the decision maker is uncertain about the parameters of the underlying process. In a first part we consider problems of optimal stopping under drift ambiguity for one-dimensional diffusion processes. Analogously to the case of ordinary optimal stopping problems for one-dimensional Brow- nian motions we reduce the problem to the geometric problem of finding the smallest majorant of the reward function in an two-parameter function space. In a second part we solve optimal stopping problems when the underlying process can crash down. These problems are reduced to one optimal stopping problem and one Dynkin game. An explicit example is discussed.
    Date: 2011–10
  4. By: Sam Asher; Lorenzo Casaburi; Plamen Nikolov (Harvard University)
    Abstract: We study how gradualism -- increasing required levels (“thresholds”) of contributions slowly over time rather than requiring a high level of contribution immediately -- affects individuals’ decisions to contribute to a public project. Using a laboratory binary choice minimum-effort coordination game, we randomly assign participants to three treatments: starting and continuing at a high threshold, starting at a low threshold but jumping to a high threshold after a few periods, and starting at a low threshold and gradually increasing the threshold over time (the “gradualism” treatment). We find that individuals coordinate most successfully at the high threshold in the gradualism treatment relative to the other two groups. We propose a theory based on belief updating to explain why gradualism works. We also discuss alternative explanations such as reinforcement learning, conditional cooperation, inertia, preference for consistency, and limited attention. Our findings point to a simple, voluntary mechanism to promote successful coordination when the capacity to impose sanctions is limited.
    Keywords: Gradualism; Coordination; Cooperation; Public Goods; Belief-based Learning; Laboratory Experiment
    Date: 2011–10
  5. By: Nicolas Gravel (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université de la Méditerranée - Aix-Marseille II - Université Paul Cézanne - Aix-Marseille III - Ecole des Hautes Etudes en Sciences Sociales (EHESS) - CNRS : UMR6579); Patrick Moyes (GREThA - Groupe de Recherche en Economie Théorique et Appliquée - CNRS : UMR5113 - Université Montesquieu - Bordeaux IV)
    Abstract: We show that it is possible to reconcile the utilitarian and welfarist principles under the requirement of unanimity provided that the set of profiles over which the consensus is attained is rich enough. More precisely, we identify a closedness condition which, if satisfied by a class of n-tuples of utility functions, guarantees that the rankings of social states induced by utilitarian and welfarist unanimities over that class are identical. We illustrate the importance of the result for the measurement of unidimensional as well as multidimensional inequalities from a dominance point of view.
    Keywords: Unanimity; Utilitarianism; Welfarism; Stochastic Dominance; Inequality
    Date: 2011–10–20
  6. By: Leonard J. Mirman; Marc Santugini
    Abstract: Building on Kihlstrom and Mirman (1974)’s formulation of risk aversion in the case of multidimensional utility functions, we study the effect of risk aversion on optimal behavior in a general consumer’s maximization problem under uncertainty. We completely characterize the relationship between changes in risk aversion and classical demand theory. We show that the effect of risk aversion on optimal behavior is determined not by the riskiness of the risky good, but rather the riskiness of the utility gamble associated with each decision. We also discuss the appropriateness of an (alternative) approach to study risk aversion suggested by Selden (1978), which has been widely popularized in the field of macroeconomics through the parametric model of Epstein and Zin (1989) (henceforth, the Selden-EZ approach). We show that the Selden-EZ approach cannot disentangle risk aversion from tastes, and, thus, cannot be used to isolate the effect of risk aversion.
    Keywords: Classical Demand Theory, Consumer Choice, Epstein-Zin preferences, Risk Aversion, Selden Preferences
    JEL: D01 D81 D91
    Date: 2011
  7. By: Rachmilevitch, Shiran (Department of Economics, University of Haifa)
    Abstract: I characterize the proportional N-person bargaining solutions by individual rationality, translation invariance, feasible set continuity, and a new axiom - interim improvement. The latter says that if the disagreement point d is known, but the feasible set is not - it may be either S or T, where S is a subset of T - then there exists a point d' in S, d' > d, such that replacing d with d' as the disagreement point would not change the final bargaining outcome, no matter which feasible set will be realized, S or T. In words, if there is uncertainty regarding a possible expansion of the feasible set, the players can wait until it is resolved; in the meantime, they can find a Pareto improving interim outcome to commit to - a commitment that has no effect in case negotiations succeed, but promises higher disagreement payoffs to all in case negotiations fail prior to the resolution of uncertainty.
    Keywords: Bargaining; Proportional solutions
    JEL: C78 D74
    Date: 2011–10–09
  8. By: Rachmilevitch, Shiran (Department of Economics, University of Haifa)
    Abstract: I study collusion between two bidders in a general symmetric IPV repeated auction, without communication, side transfers, or public randomization. I construct a collusive scheme, endogenous bid rotation, that generates a payoff larger than the bid rotation payoff.
    Keywords: Auctions; Bid rotation; Collusion; Repeated games
    JEL: D44 D82
    Date: 2011–10–09
  9. By: Rachmilevitch, Shiran (Department of Economics, University of Haifa)
    Abstract: A bargaining solution balances fairness and efficiency if each player's payoff lies between the minimum and maximum of the payoffs assigned to him by the egalitarian and utilitarian solutions. In the 2-person bargaining problem, the Nash solution is the unique scale-invariant solution satisfying this property. Additionally, a similar result, relating the weighted egalitarian and utilitarian solutions to a weighted Nash solution, is obtained. These results are related to a theorem of Shapley, which I generalize. For n>=3, there does not exist any n-person scale-invariant bargaining solution that balances fairness and efficiency.
    Keywords: Bargaining; fairness; efficiency; Nash solution
    JEL: D63 D71
    Date: 2011–10–09
  10. By: K.Vela Velupillai
    Abstract: A re-interpretation of the asymmetric roles assigned to the two agents in the genesis of Newcomb’s Paradox is suggested. The re-interpretation assigns a more active role for the 'rational' agent and a possible Turing Machine interpretation for the behaviour of the demon (alias 'being from another planet, with an advanced technology and science,..,etc.'). These modifications, while introducing new conundrums to an already diabolical interaction, do allow the 'rational' agent, as a computably behavioural agent, to make a clear decision, if any decision is possible at all. This latter caveat is necessary because in the Turing Machine formulation, the computably behavioural agent might have to face algorithmic undecidabilities
    Date: 2011
  11. By: Dominiak, Adam; Lefort, Jean-Philippe
    Abstract: This paper explores the relationship between dynamic consistency and existing notions of unambiguous events for Choquet expected utility preferences. A decision maker is faced with an information structure represented by a filtration. We show that the decision maker’s preferences respect dynamic consistency on a fixed filtration if and only if the last stage of the filtration is composed of unambiguous events in the sense of Nehring (Math Social Sci 38:197–213, 1999). Adopting two axioms, conditional certainty equivalence consistency and constrained dynamic consistency to filtration measurable acts, it is shown that the decision maker respects these two axioms on a fixed filtration if and only if the last stage of the filtration is made up of unambiguous events in the sense of Zhang (Econ Theory 20:159–181, 2002).
    Keywords: Choquet expected utility; Unambiguous events; Filtration; Updating; Dynamic consistency; Consequentialism;
    JEL: D81 D82
    Date: 2011–04
  12. By: Alexander K. Karaivanov; Fernando M. Martin
    Abstract: We revisit the role of limited commitment in a dynamic risk-sharing setting with private information. We show that a Markov-perfect equilibrium, in which agent and insurer cannot commit beyond the current period, and an infinitely-long contract to which only the insurer can commit, implement identical consumption, effort and welfare outcomes. Unlike contracts with full commitment by the insurer, Markov-perfect contracts feature non-trivial and determinate asset dynamics. Numerically, we show that Markov-perfect contracts provide sizable insurance, especially at low asset levels, and are able to explain a significant part of wealth inequality beyond what can be explained by self-insurance. The welfare gains from resolving the commitment friction are larger than those from resolving the moral hazard problem at low asset levels, while the opposite holds for high asset levels.
    Keywords: Moral hazard ; Risk
    Date: 2011
  13. By: Alexander K. Karaivanov; Fernando M. Martin
    Abstract: This paper analyzes dynamic risk-sharing contracts between profit-maximizing insurers and risk-averse agents who face idiosyncratic income uncertainty and may self-insure through savings. We study Markov-perfect insurance contracts in which neither party can commit beyond the current period. We show that the limited commitment assumption on the insurer's side is only restrictive when he is endowed with a rate of return advantage and the agent has sufficiently large initial assets. In such a case, the consumption profile is distorted relative to the first-best. In a Markov-perfect equilibrium, the agent's asset holdings determine his period outside option and are thus, an integral part of insurance contracts, unlike the case when the insurer can commit. Whether the parties can contract on the agent's savings decisions or not affects the agreement as long as the insurer makes positive profits.
    Keywords: Contracts ; Risk
    Date: 2011
  14. By: Mackowiak, Bartosz Adam; Wiederholt, Mirko
    Abstract: Why were people so unprepared for the global financial crisis, the European debt crisis, and the Fukushima nuclear accident? To address this question, we study a model in which agents make state-contingent plans - think about actions in different contingencies - subject to the constraint that agents can process only a limited amount of information. The model predicts that agents are unprepared in a state when the state has a low probability, the optimal action in that state is uncorrelated with the optimal action in normal times, and actions are strategic complements. We then compare the equilibrium allocation of attention to the efficient allocation of attention. We characterize analytically the conditions under which society would be better off if agents thought more carefully about optimal actions in rare events.
    Keywords: disasters; efficiency; rare events; rational inattention
    JEL: D83 E58 E60
    Date: 2011–10

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