nep-mic New Economics Papers
on Microeconomics
Issue of 2011‒12‒19
twenty papers chosen by
Jing-Yuan Chiou
IMT Lucca Institute for Advanced Studies

  1. Adverse Selection Without Single Crossing By Schottmuller, C.
  2. Negotiation-proof correlated equilibrium By Nicholas Ziros
  3. Procurement with Specialized Firms By Boone, J.; Schottmuller, C.
  4. Demand For Contract Enforcement in A Barter Environment By Rubinchik, Anna; Samaniego, Roberto M.
  5. Self-Commitment-Institutions and Cooperation in Overlapping Generations Games By Francesco Lancia; Alessia Russo
  6. Which Way to Cooperate By Todd R. Kaplan; Bradley J. Ruffle Author-X-Name-Bradley J.
  7. Games with synergistic preferences By Julian C. Jamison
  8. One Theory For Two Risk Premia By Emmanuelle GABILLON (GREThA, CNRS, UMR 5113)
  9. On the game interpretation of a shadow price process in utility optimization problems under transaction costs By Dmitry B. Rokhlin
  10. Utility Maximization with Addictive Consumption Habit Formation in Incomplete Semimartingale Markets By Xiang Yu
  11. Sequential All-Pay Auctions with Head Starts and Noisy Outputs By Ella Segev; Aner Sela
  12. Timing of Messages and the Aumann Conjecture: A multiple-Selves Approach By Roi Zultan
  14. Entrepreneurial Choice and Knightian Uncertainty with Borrowing Constraints By Takanori Adachi; Takao Asano
  15. Reference dependent ambiguity aversion: theory and experiment By Qiu, Jianying; Weitzel, Utz
  16. Models of Subjective Learning By David Dillenberger; Philipp Sadowski
  17. The Role of Information in Competitive Experimentation By Ufuk Akcigit; Qingmin Liu
  18. Good rankings are bad - Why reliable rankings can hurt consumers By Bouton, Laurent; Kirchsteiger, Georg
  19. The economics of predation: What drives pricing when there is learning-by-doing? By Besanko, David; Doraszelski, Ulrich; Kryukov, Yaroslav
  20. The Washroom Game By Jan Heufer

  1. By: Schottmuller, C. (Tilburg University, Center for Economic Research)
    Abstract: Some results can be readily applied. For example, overinsurance, i.e. insurance levels above first best as in 'Cadillac' insurance plans, can be rationalized. In a non-linear pricing framework, the model also provides an explanation for marginal prices below marginal costs as observed in flat rate offers.
    Keywords: adverse selection;single crossing;Spence-Mirrlees condition;global incentive compatibility.
    JEL: D82 D86 L11
    Date: 2011
  2. By: Nicholas Ziros
    Abstract: This article characterizes the set of correlated equilibria that result from open negotiations, which players make prior to playing a strategic game. A negotiation-proof correlated equilibrium is defined as a correlated strategy in which the negotiation process among all of the players prevents the formation of any improving coalitional deviation. Additionally, this notion of equilibrium is adapted to general games with incomplete information.
    Keywords: Correlated equilibrium, coalitions, negotiation, incomplete information
    Date: 2011–12
  3. By: Boone, J.; Schottmuller, C. (Tilburg University, Center for Economic Research)
    Abstract: This paper analyzes optimal procurement mechanisms in a setting where the procurement agency has incomplete information concerning the firms’ cost functions and cares about quality as well as price. Low type firms are cheaper than high type firms in providing low quality but more expensive when providing high quality. Hence, each type is specialized in a certain quality level. We show that this specialization leads to a bunching of types on profits, i.e. a range of firms with different cost functions receives zero profits and therefore no informational rents. If first best welfare is monotone in the efficiency parameter, the optimal mechanism can be implemented by a simple auction. If first best welfare is U-shaped in type, the optimal mechanism is not efficient in the sense that types providing a lower second best welfare win against types providing a higher second best welfare.
    Keywords: procurement;specialization;deregulation.
    JEL: H75 L51
    Date: 2011
  4. By: Rubinchik, Anna (Department of Economics, University of Haifa); Samaniego, Roberto M. (Department of Economics, The George Washington University)
    Abstract: Do greater potential gains from trade enhance or erode contracting institutions? In an anonymous exchange environment traders can sign a contract, hence agreeing to interact with the assigned partner, or wait till the next match. Any contract can be endorsed (for a pay) by the enforcement agency, which then observes the interaction with a positive probability known to the traders and punishes the detected infractors. The agency enforces only those contracts that are paid for, and a trader freely chooses whether to endorse his contract. Demand for contract enforcement is the highest amount a proposer of a contract is ready to pay to the agency (in a stationary subgame perfect equilibrium). It may be strictly positive, as we show, even when contracts are broken. Surprisingly, larger potential gains from exchange may dampen the demand, but not always: they may boost the demand for 'high quality' agencies (that oversee the interactions frequently enough).
    Keywords: Contracting institutions, third party enforcement, demand for contracts, gains from trade
    JEL: H11 H41 K42
    Date: 2011–12–06
  5. By: Francesco Lancia; Alessia Russo
    Abstract: This paper focuses on a two-period OLG economy with public imperfect observability over the intergenerational cooperative dimension. Individual endowment is at free disposal and perfectly observable. In this environment we study how a new mechanism, we call Self-Commitment-Institution (SCI), outperforms personal and community enforcement in achieving higher ex-ante e¢ ciency. Social norms with and without SCI are characterized. If social norms with SCI are implemented, agents might freely dispose of their endowment. As long as they reduce their marginal gain from deviation in terms of current utility, they also credibly self-commit on intergenerational cooperation. Under quite general conditions we .nd that, even if individual strategies are still characterized by behavioral uncertainty, the introduction of SCI relaxes the inclination toward opportunistic behavior and sustains higher e¢ ciency compared to social norms without SCI. We quantify the value of SCI and investigate the role of memory with di¤erent social norms. Finally, applications on intergenerational public good games and transfer games with productive SCI are provided
    Keywords: Cooperation; Free disposal; Imperfect public monitoring; Memory; Overlapping generation game; Self-Commitment Institution;
    JEL: C70 D70 H40
    Date: 2011–11
  6. By: Todd R. Kaplan (Department of Economics, University of Haifa, Israel.); Bradley J. Ruffle Author-X-Name-Bradley J. (Department of Economics, Ben-Gurion University, Beer Sheva, Israel.)
    Abstract: We introduce a two-player, binary-choice game in which both players have a privately known incentive to enter, yet the combined surplus is highest if only one enters. Repetition of this game admits two distinct ways to cooperate: turn taking and cutoffs, which rely on the player’s private value to entry. A series of experiments highlights the role of private information in determining which mode players adopt. If an individual’s entry values vary little (e.g., mundane tasks), taking turns is likely; if these potential values are diverse (e.g., difficult tasks that differentiate individuals by skill or preferences), cutoff cooperation emerges.
    JEL: C90 Z13
    Date: 2011
  7. By: Julian C. Jamison
    Abstract: In economic situations a player often has preferences regarding not only his or her own outcome but also regarding what happens to fellow players, concerns that are entirely apart from any strategic considerations. While this can be modeled directly by simply writing down a player's final preferences, these are commonly unknown a priori. In many cases it is therefore both helpful and instructive to explicitly model these interactions. This paper, building on a model due to Bergstrom (1989, 1999), presents a simple structure in the context of game theory that incorporates the "synergies" between players. It is powerful enough to cover a wide range of such interactions and model many disparate experimental and empirical results, yet it is straightforward enough to be used in many applied situations where altruism, or a baser motive, is implied.
    Keywords: Human behavior ; Game theory ; Altruism
    Date: 2011
  8. By: Emmanuelle GABILLON (GREThA, CNRS, UMR 5113)
    Abstract: Generally, in the standard presentation of the expected utility model, the risk premium represents how much a risk-averse decision maker is ready to pay to have a risk eliminated. Here, however, we introduce a different risk premium: how much should a risk (which could be the return on a financial asset) yield to be acceptable to a risk-averse decision maker. Although our risk premium is derived from the Pratt bid price, it should not be confused with it: the Pratt bid price represents the monetary compensation of a risk. The standard risk premium refers to risk-avoidance; our risk premium, however, refers to risk-taking. We then reanalyse the main results concerning risk aversion under expected utility using this risk premium tool and deduce its main properties.
    Keywords: choices under uncertainty, expected utility, risk aversion, risk premium.
    JEL: D81
    Date: 2011
  9. By: Dmitry B. Rokhlin
    Abstract: To any utility maximization problem under transaction costs one can assign a frictionless model with a price process $S^*$, lying in the bid/ask price interlval $[\underline S, \bar{S}]$. Such process $S^*$ is called a \emph{shadow price} if it provides the same optimal utility value as in the original model with bid-ask spread. We call $S^*$ a \emph{generalized shadow price} if the above property is true for the \emph{relaxed} utility function in the frictionless model. This relaxation is defined as the lower semicontinuous envelope of the original utility, considered as a function on the set $[\underline S, \bar{S}]$, equipped with some natural weak topology. We prove the existence of a generalized shadow price under rather weak assumptions and mark its relation to a saddle point of the trader/market zero-sum game, determined by the relaxed utility function. The relation of the notion of a shadow price to its generalization is illustrated by several examples. Also, we briefly discuss the interpretation of shadow prices via Lagrange duality.
    Date: 2011–12
  10. By: Xiang Yu
    Abstract: This paper studies the problem of continuous time utility maximization of consumption together with addictive habit formation in general incomplete semimartingale financial markets. By introducing the auxiliary state processes and the modified dual space, we embed our original problem into an auxiliary time separable utility maximization problem with the shadow random endowment. We establish existence and uniqueness of the optimal solution using convex duality approach on the product space by defining the primal value function both on the initial wealth and initial habit. We also provide market independent sufficient conditions both on stochastic discounting processes for the habit formation process and on the utility function for the validity of several key assertions of our main results to hold true.
    Date: 2011–12
  11. By: Ella Segev (Department of Industrial Engineering and Management,Ben-Gurion University of the Negev, Israel); Aner Sela (Economics Department, Ben-Gurion University of the Negev, Ben-Gurion University of the Negev, Israel)
    Abstract: We study a sequential (Stackelberg) all-pay auction with two contestants who are privately informed about a parameter (ability) that affects their cost of effort. Contestant 1 (the fi?rst mover) exerts an effort in the fi?rst period, while contestant 2 (the second mover) observes the effort of contestant 1 and then exerts an effort in the second period. Contestant 2 wins the contest if his effort is larger than or equal to the effort of contestant 1; otherwise, contestant 1 wins. We characterize the unique subgame perfect equilibrium of this sequential all-pay auction and analyze the use of head starts to improve the contestants' performances. We also study this model when contestant 1 exerts an effort in the fi?rst period which translates into an observable output but with some noise. We study two variations of this model where contestant 1 either knows or does not know the realization of the noise before she chooses her effort. Contestant 2 does not know the realization of the noise in both variations. For both variations, we characterize the subgame perfect equilibrium and investigate the effect of a random noise on the contestants' performance.
    Keywords: Sequential all-pay auctions, head starts, noisy outputs.
    JEL: D44 O31 O32
    Date: 2011
  12. By: Roi Zultan (Department of Economics, Ben-Gurion University of the Negev, Beer-Sheva 84105, Israel)
    Abstract: The Aumann (1990) conjecture states that cheap-talk messages do not necessarily help to coordinate on efficient Nash equilibria. In an experimental test of Aumann’s conjecture, Charness (2000) found that cheap-talk messages facilitate coordination when they precede the action, but not when they follow the action. Standard game-theoretical modeling abstracts from this timing effect, and therefore cannot account for it. To allow for a formal analysis of the timing effect, I study the sequential equilibria of the signaling game in which the sender is modeled as comprising two selves: an acting self and a signaling self. I interpret Aumann’s argument in this context to imply that all of the equilibria in this game are ‘babbling’ equilibria, in which the message conveys no information and does not affect the behavior of the receiver. Using this framework, I show that a fully communicative equilibrium exists—only if the message precedes the action but not when the message follows the action. In the latter case, no information is transmitted in any equilibrium. This result provides a game-theoretical explanation for the puzzling experimental results obtained by Charness (2000). I discuss other explanations for this timing-of-message effect and their relationship to the current analysis.
    Keywords: pre-play communication, Nash equilibrium, coordination games, multiple selves
    JEL: A13 C72 C91 D82 D84
    Date: 2011
  13. By: Stefano D'Addona (University of Roma Tre); Frode Brevik (Free University Amsterdam)
    Abstract: We document an unpleasant feature of Epstein-Zin preferences in a stylized model economy of the long-run risk type now widespread in Asset Pricing: Agents with preference parameters commonly described as indicating a "preference for early resolution of uncertainty" achieve higher utility levels if they can commit to ignoring information on the state of the business cycle. For parameter choices similar to those used to explain asset prices, an agent can achieve utility gains equivalent to a more than 40 % increase in life-time consumption by committing to ignore information on the trend growth rate of the endowment good. We show that opting for such a coarser information set can be implemented and supported as an equilibrium strategy.
    Keywords: Recursive preferences; Epstein-Zin preferences; Uncertainty aversion; Information processing; Time inconsistency
    JEL: D83 D84 E32
    Date: 2011
  14. By: Takanori Adachi (School of Economics, Nagoya University); Takao Asano (Faculty of Economics, Okayama University)
    Abstract: This paper studies the effects of Knightian uncertainty, or ambiguity, on entrepreneurial choice. By distinguishing between risk and ambiguity, we first show that ambiguity aversion makes it less likely that an individual will become an entrepreneur. It is also shown that an increase in ambiguity unambiguously reduces the amount of investment. In the presence of borrowing constraints, the less ambiguity averse is the individual, the more likely is his or her investment to be constrained. More importantly, constrained wage workers, who would become entrepreneurs in the absence of credit market imperfection, emerge if and only if the market wage is high enough. These individuals are characterized by an intermediate degree of ambiguity aversion. When interpreting these constrained wage workers as managerial and professional workers, our model predicts the rise of such workers in the process of economic development.
    Keywords: Entrepreneurship, Knightian Uncertainty, Risk, Borrowing Constraints
    JEL: L26 D8
    Date: 2011–12
  15. By: Qiu, Jianying; Weitzel, Utz
    Abstract: In standard models of ambiguity, the evaluation of an ambiguous asset, as of a risky asset, is considered as an independent process. In this process only information directly pertaining to the ambiguous asset is used. These models face significant challenges from the finding that ambiguity aversion is more pronounced when an ambiguous asset is evaluated alongside a risky asset than in isolation. To explain this phenomenon, we developed a theoretical model based on reference dependence in probabilities. According to this model, individuals (1) form subjective beliefs on the potential winning probability of the ambiguous asset; (2) use the winning probability of the (simultaneously presented) risky asset as a reference point to evaluate the potential winning probabilities of the ambiguous asset; (3) code potential winning probabilities of the ambiguous asset that are greater than the reference point as gains and those that are smaller than the reference point as losses; (4) weight losses in probability heavier than gains in probability. We tested the crucial assumption, reference dependence in probabilities, in an experiment and found supporting evidence.
    Keywords: Ambiguity Aversion, Reference Point, Comparison, Experiment
    JEL: G1 C9
    Date: 2011–11–01
  16. By: David Dillenberger (Department of Economics, University of Pennsylvania); Philipp Sadowski (Department of Economics, Duke University)
    Abstract: We study a decision maker who faces a dynamic decision problem in which the process of information arrival is subjective. By studying preferences over menus of acts, we derive a sequence of utility representations that captures the decision maker’s uncertainty about the beliefs he will hold when choosing from a menu. In the most general model of second-order beliefs, we characterize a notion of "more preference for flexibility" via a subjective analogue of Blackwell’s (1951, 1953) comparisons of experiments. We proceed to analyze a model in which signals are subsets of the state space. The corresponding representation enables us to compare the behavior of two decision makers who expect to learn differently, even if they do not agree on their prior beliefs. The class of information systems that can support such a representation generalizes the notion of modeling information as a partition of the state space. We apply the model to study a decision maker who anticipates subjective uncertainty to be resolved gradually over time. We derive a representation that uniquely identifies both the filtration, which is the timing of information arrival with the sequence of partitions it induces, and the decision maker’s prior beliefs.
    Keywords: Resolution of uncertainty, second-order beliefs, preference for flexibility, valuing binary bets more, generalized partition.
    JEL: D80 D81
    Date: 2011–12–12
  17. By: Ufuk Akcigit (Department of Economics, University of Pennsylvania); Qingmin Liu (Department of Economics, University of Pennsylvania)
    Abstract: Technological progress is typically a result of trial-and-error research by competing firms. While some research paths lead to the innovation sought, others result in dead ends. Because firms benefit from their competitors working in the wrong direction, they do not reveal their dead-end findings. Time and resources are wasted on projects that other firms have already found to be dead ends. Consequently, technological progress is slowed down, and the society benefits from innovations with delay, if ever. To study this prevalent problem, we build a tractable two-arm bandit model with two competing firms. The risky arm could potentially lead to a dead end and the safe arm introduces further competition to make firms keep their dead-end findings private. We characterize the equilibrium in this decentralized environment and show that the equilibrium necessarily entails significant efficiency losses due to wasteful dead-end replication and a flight to safety - an early abandonment of the risky project. Finally, we design a dynamic mechanism where firms are incentivized to disclose their actions and share their private information in a timely manner. This mechanism restores efficiency and suggests a direction for welfare improvement.
    Keywords: Learning, Two-arm Bandit, R&D Competition, Dead-end Inefficiency, Trial-and-error
    JEL: O31 D83 D92
    Date: 2011–11–08
  18. By: Bouton, Laurent; Kirchsteiger, Georg
    Abstract: Ranking have become increasingly popular on markets for study programs, restaurants, wines, cars, etc. This paper analyses the welfare implication of such rankings. Consumers have to make a choice between two goods of unknown quality with exogenous presence or absence of an informative ranking. We show that existence of the ranking might make all consumers worse off. The existence of a ranking changes the demand structure of consumers. With rigid prices and rationing, the change can be detrimental to consumers due to its effect on rationing. Furthermore, this change in demand can also be detrimental due to consumption externalities. Finally, with perfectly flexible prices the ranking might increase the market power of firms and hence lead to losses for all consumers.
    Keywords: Consumer Welfare; Externalities; Market Power; Rankings; Rationing
    JEL: D1 D4 D6 D8 L1
    Date: 2011–12
  19. By: Besanko, David; Doraszelski, Ulrich; Kryukov, Yaroslav
    Abstract: Predatory pricing--a deliberate strategy of pricing aggressively in order to eliminate competitors--is one of the more contentious areas of antitrust policy and its existence and efficacy are widely debated. The purpose of this paper is to formally characterize predatory pricing in a modern industry dynamics framework. We endogenize competitive advantage and industry structure through learning-by-doing. We first show that predation-like behavior arises routinely in our model. Equilibria involving predation-like behavior typically coexist with equilibria involving much less aggressive pricing. To disentangle predatory pricing from mere competition for efficiency on a learning curve we next decompose the equilibrium pricing condition. Our decomposition provides us with a coherent and flexible way to develop alternative characterizations of a firm’s predatory pricing incentives, some of which are motivated by the existing literature while others are novel. We finally measure the impact of the predatory pricing incentives on industry structure, conduct, and performance. We show that forcing a firm to ignore these incentives in setting its price can have a large impact and that this impact stems from eliminating equilibria with predation-like behavior. Along with the predation-like behavior, however, a fair amount of competition for the market is eliminated. Overall, the distinction between predatory pricing and pricing aggressively to pursue efficiency is closely related to the distinction between the advantage-building and advantage-denying motives that our decomposition of the equilibrium pricing condition isolates and measures.
    Keywords: competition policy; industry dynamics; predatory pricing
    JEL: C73 L13 L44
    Date: 2011–12
  20. By: Jan Heufer
    Abstract: This article analyses a game where players sequentially choose either to become insiders and pick one of finitely many locations or to remain outsiders. They will only become insiders if a minimum distance to the next player can be assured; their secondary objective is to maximise the minimal distance to other players. This is illustrated by considering the strategic behaviour of men choosing from a set of urinals in a public lavatory. However, besides very similar situations (e.g. settling of residents in a newly developed area, the selection of food patches by foraging animals, choosing seats in waiting rooms or lines in a swimming pool), the game might also relevant to the problem of placing billboards attempting to catch the attention of passers-by or similar economic situations. In the non-cooperative equilibrium, all insiders behave as if they cooperated with each other and minimised the total number of insiders. It is shown that strategic behaviour leads to an equilibrium with substantial underutilization of available locations. Increasing the number of locations tends to decrease utilization. The removal of some locations which leads to gaps can not only increase relative utilization but even absolute maximum capacity.
    Keywords: Efficient design of facilities; location games; privacy concerns; strategic entry prevention; unfriendly seating arrangement; urinal problem
    JEL: C70 H89 R12
    Date: 2011–11

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