nep-mic New Economics Papers
on Microeconomics
Issue of 2013‒05‒05
fifteen papers chosen by
Jing-Yuan Chiou
IMT Lucca Institute for Advanced Studies

  1. Learning in a Black Box By Heinrich H. Nax; Maxwell N. Burton-Chellew; Stuart A. West; H. Peyton Young
  2. More is Less: Why Parties May Deliberately Write Incomplete Contracts By Maija Halonen-Akatwijuka; Oliver D. Hart
  3. Biology and the Arguments of Utility By Luis Rayo; Arthur Robson
  4. Discounting under Disagreement By Geoffrey Heal; Antony Millner
  5. Scoring Rules for Subjective Probability Distributions By Glenn W. Harrison; Jimmy Martínez-Correa; J. Todd Swarthout; Eric R. Ulm
  6. Up close it feels dangerous: 'anxiety' in the face of risk By Thomas M. Eisenbach; Martin C. Schmalz
  7. Top Guns May Not Fire: Best-Shot Group Contests with Group-Specific Public Good Prizes By Chowdhury , Subhasish; Lee , Dongryul; Sheremeta , Roman
  8. Bubbles are rational By Pierre Lescanne
  9. Extending the Original Position: Revisiting the Pattanaik Critique of Vickrey/Harsanyi Utilitarianism By Peter J. Hammond
  10. The Hidden Cost of Specialization By Fabio Landini; Antonio Nicolò; Marco Piovesan
  11. Differential Pricing When Costs Differ: A Welfare Analysis By Yongmin Chen and Marius Schwartz
  12. Optimal Inequality behind the Veil of Ignorance By Liang, Che-Yuan
  14. Arrow's paradox and markets for nonproprietary information By Leppälä, Samuli
  15. Ambiguity, Pessimism, Optimism and Financial Crises in a Simple Global Game Model By Daniel Laskar

  1. By: Heinrich H. Nax (PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - École des Hautes Études en Sciences Sociales [EHESS] - Ecole des Ponts ParisTech - Ecole normale supérieure de Paris - ENS Paris - Institut national de la recherche agronomique (INRA), EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris); Maxwell N. Burton-Chellew (Department of Zoology - University of Oxford (UK)); Stuart A. West (Department of Zoology - University of Oxford (UK)); H. Peyton Young (Department of Economics - University of Oxford (UK))
    Abstract: Many interactive environments can be represented as games, but they are so large and complex that individual players are in the dark about what others are doing and how their own payo s are a ected. This paper analyzes learning behavior in such 'black box' environments, where players' only source of information is their own history of actions taken and payoff s received. Speci fically we study repeated public goods games, where players must decide how much to contribute at each stage, but they do not know how much others have contributed or how others' contributions a effect their own payoff s. We identify two key features of the players' learning dynamics. First, if a player's realized payoff increases he is less inclined to change his strategy, whereas if his realized payo ff decreases he is more inclined to change his strategy. Second, if increasing his own contribution results in higher payoff s he will tend to increase his contribution still further, whereas the reverse holds if an increase in contribution leads to lower payo ffs. These two e ffects are clearly present when players have no information about the game; moreover they are still present even when players have full information. Convergence to Nash equilibrium occurs at about the same rate in both situations.
    Keywords: Learning ; Information ; Public goods games
    Date: 2013–04
  2. By: Maija Halonen-Akatwijuka; Oliver D. Hart
    Abstract: Why are contracts incomplete? Transaction costs and bounded rationality cannot be a total explanation since states of the world are often describable, foreseeable, and yet are not mentioned in a contract. Asymmetric information theories also have limitations. We offer an explanation based on “contracts as reference points”. Including a contingency of the form, “The buyer will require a good in event E”, has a benefit and a cost. The benefit is that if E occurs there is less to argue about; the cost is that the additional reference point provided by the outcome in E can hinder (re)negotiation in states outside E. We show that if parties agree about a reasonable division of surplus, an incomplete contract can be strictly superior to a contingent contract.
    JEL: D23 D86 K12
    Date: 2013–04
  3. By: Luis Rayo (London School of Economics); Arthur Robson (Simon Fraser University)
    Abstract: Why did evolution not give us a utility function that is offspring alone? Why do we care intrinsically about other outcomes, such as food, and what determines the intensity of such preferences? A common view is that such other outcomes enhance fitness and the intensity of our preference for a given outcome is proportional to its contribution to fitness. We argue that this view is incomplete. Specifically, we show that in the presence of informational asymmetries, the evolutionarily most desirable preference for a given outcome is determined not only by the significance of the outcome, but by the Agent's degree of ignorance regarding its significance. Our model also sheds light on the phenomena of peer effects and prepared learning, whereby some peer attitudes are more influential than others.
    Keywords: Utility, Biological evolution
    JEL: D01 D80
    Date: 2013–04
  4. By: Geoffrey Heal; Antony Millner
    Abstract: A group of time consistent agents has access to a productive resource stock whose output meets their consumption needs. The agents disagree about the appropriate pure rate of time preference to use when choosing a consumption policy, and thus delegate the management of the resource to a social planner who allocates consumption efficiently across individuals and over time. We show that the planner's optimal policy is equivalent to that of a representative agent with a time varying rate of impatience. The representative agent's time preferences depend on the distribution of time preferences in the group, on the agents' tolerance for consumption fluctuations, and on the productivity of the resource. The representative agent's rate of impatience coincides with that of the individual with the lowest rate of impatience in the long run, and under plausible conditions is monotonically declining. In the work-horse case of iso-elastic felicity functions and Gamma distributed rates of impatience, analytic solutions are possible, and the representative agent has hyperbolic time preferences. We thus provide a normative justification for the use of declining rates of time preference in dynamic welfare analysis.
    JEL: D61 D99
    Date: 2013–04
  5. By: Glenn W. Harrison; Jimmy Martínez-Correa; J. Todd Swarthout; Eric R. Ulm
    Abstract: The theoretical literature has a rich characterization of scoring rules for eliciting the subjective beliefs that an individual has for continuous events, but under the restrictive assumption of risk neutrality. It is well known that risk aversion can dramatically affect the incentives to correctly report the true subjective probability of a binary event, even under Subjective Expected Utility. To address this one can "calibrate" inferences about true subjective probabilities from elicited subjective probabilities over binary events, recognizing the incentives that risk averse agents have to distort reports. We characterize the comparable implications of the general case of a risk averse agent when facing a popular scoring rule over continuous events, and find that these concerns do not apply with anything like the same force. For empirically plausible levels of risk aversion, one can reliably elicit most important features of the latent subjective belief distribution without undertaking calibration for risk attitudes providing one is willing to assume Subjective Expected Utility.
    Date: 2013–04
  6. By: Thomas M. Eisenbach; Martin C. Schmalz
    Abstract: Motivated by individuals' emotional response to risk at different time horizons, we model an 'anxious' agent--one who is more risk averse with respect to imminent risks than distant risks. Such preferences describe well-documented features of 1) individual behavior, 2) equilibrium prices, and 3) institutions. In particular, we derive implications for financial markets, such as overtrading and price anomalies around announcement dates, as well as a downward-sloping term structure of risk premia, which are found empirically. Since such preferences can lead to dynamic inconsistencies with respect to risk trade-offs, we show that costly delegation of investment decisions is a strategy used to cope with 'anxiety.'
    Keywords: Risk management ; Risk-taking (Psychology) ; Human behavior ; Investments ; Rate of return
    Date: 2013
  7. By: Chowdhury , Subhasish; Lee , Dongryul; Sheremeta , Roman
    Abstract: We analyze a group contest in which n groups compete to win a group-specific public good prize. Group sizes can be different and any player may value the prize differently within and across groups. Players exert costly efforts simultaneously and independently. Only the highest effort (the best-shot) within each group represents the group effort that determines the winning group. We fully characterize the set of equilibria and show that in any equilibrium at most one player in each group exerts strictly positive effort. There always exists an equilibrium in which only the highest value player in each active group exerts strictly positive effort. However, perverse equilibria may exist in which the highest value players completely free-ride on others by exerting no effort. We provide conditions under which the set of equilibria can be restricted and discuss contest design implications.
    Keywords: best-shot technology; group contest; group-specific public goods; free-riding
    JEL: C72 D70 D72 H41
    Date: 2013–04–27
  8. By: Pierre Lescanne (LIP - Laboratoire de l'Informatique du Parallélisme - Université de Lyon - CNRS : UMR5668 - INRIA - École Normale Supérieure - Lyon - Université Claude Bernard - Lyon I)
    Abstract: As we show using the notion of equilibrium in the theory of infinite sequential games, bubbles and escalations are rational for economic and environmental agents, who believe in an infinite world. This goes against a vision of a self regulating, wise and pacific economy in equilibrium. In other words, in this context, equilibrium is not a synonymous of stability. We attempt to draw from this statement methodological consequences and a new approach to economics. To the mindware of economic agents (a concept due to cognitive psychology) we propose to add coinduction to properly reason on infinite games. This way we refine the notion of rationality.
    Keywords: economic game; infinite game;sequential game;bubble; escalation; microeconomics;speculative bubble; induction;coinduction.
    Date: 2013–04–30
  9. By: Peter J. Hammond
    Abstract: Harsanyi's original position treats personal identity, upon which each individual's utility depends, as risky. Pattanaik's critique is related to the problem of scaling "state-dependent" von Neumann-Morgenstern utility when determining subjective probabilities. But a unique social welfare functional, incorporating both level and unit interpersonal comparisons, emerges from contemplating an "extended" original position allowing the probability of becoming each person to be chosen. Moreover, the paper suggests the relevance of a "Harsanyi ethical type space", with types as both causes and objects of preference.
    Date: 2013–04
  10. By: Fabio Landini (MEDAlics and CRIOS, Bocconi University); Antonio Nicolò (University of Padua); Marco Piovesan (Department of Food and Resource Economics, University of Copenhagen)
    Abstract: Given the advantages of specialization, employers encourage their employees to acquire distinct expertise to better satisfy clients’ needs. However, when the client is unaware of the employees’ expertise and cannot be sorted out to the most competent employee by means of a gatekeeper, a mismatch can occur. In this paper we attempt to identify the optimal condition so an employer can eliminate this mismatch and offer a team bonus that provides the first-contacted employee with an incentive to refer the client to the correct expert. We show that the profitability of this referral contract increases with the agents’ degree of specialization and decreases with the clients’ competence at identifying the correct expert. Interestingly, a referral contract may be more profitable than an individual contract -that does not pay a team bonus- even if the former provides less incentive to the agents to improve their expertise. Thus, we provide a new rationale for the use of team bonuses even when the production function depends on a single employee’s effort.
    Keywords: Team and Individual Contracts, Matching Client-Expert, Incentives to Refer
    JEL: C72 D01 D21 D86 M52
    Date: 2013–04
  11. By: Yongmin Chen and Marius Schwartz (Department of Economics, Georgetown University)
    Abstract: This paper analyzes the welfare effects of monopoly differential pricing in the important but largely neglected case where marginal costs of service differ across consumer groups. Compared to uniform pricing, cost-based differential pricing generally raises total welfare. Although total output may fall or even its allocation across consumer groups may worsen, under a minor demand curvature condition at least one of these changes must be beneficial and dominate if the other is not. Aggregate consumer welfare also rises (under a mildly tighter condition). The source of consumer gains is not cost savings from output reallocation, which flow to the firm. Rather, to induce output reallocation the firm must vary its prices, thereby creating price dispersion without an upward bias in the average price. This improves consumer welfare even in cases where output falls. We contrast these results with those in the extensive literature on third-degree price discrimination and, furthermore, provide sufficient conditions for beneficial differential pricing when both demand elasticities and costs differ.
    Keywords: differential pricing, price discrimination, demand curvature, pass-through rate JEL Codes:
    Date: 2013–01–01
  12. By: Liang, Che-Yuan (Uppsala Center for Fiscal Studies)
    Abstract: In Rawls’ (1971) influential social contract approach to distributive justice, the fair income distribution is the one that an individual would choose behind a veil of ignorance. Harsanyi (1953, 1955, 1975) treats this situation as a decision under risk and arrives at utilitarianism using expected utility theory. This paper investigates the implications of applying prospect theory instead, which better describes behavior under risk. I find that the specific type of inequality in bottom-heavy right-skewed income distributions, which includes the log-normal income distribution, could be socially desirable. The optimal inequality result contrasts the implications of other social welfare criteria.
    Keywords: veil of ignorance; prospect theory; social welfare function; income inequality
    JEL: D03 D31 D63 D81
    Date: 2013–04–29
  13. By: Gabrielsen, Tommy Staahl (Department of Economics, University of Bergen); Johansen, Bjørn Olav (Department of Economics, University of Bergen)
    Abstract: We consider a setting where an upstream producer and a competitive fringe of producers of a substitute product may sell their products to two differentiated downstream retailers. We investigate two different contracting games; one with seller power and a second game with buyer power. In each game we characterize the minimum set of vertical restraints that make the vertically integrated profit sustainable as an equilibrium outcome, and we also characterize sufficient conditions for having interlocking relationships (i.e. no exclusion). In line with the recent literature, we focus on the performance of simple two-part tariffs, upfront payments and RPM as facilitating devices for reducing competition under both buyer and seller power. With seller power we show that minimum RPM, possibly coupled with a quantity roof, will allow the manufacturer to induce industry wide monopoly prices. With buyer power we show that monopoly prices may be induced if the retailers may use an upfront fee together with a two-part tariff and a minimum RPM.
    Keywords: resale price maintenance; seller power; buyer power; horsizontal control
    JEL: L42
    Date: 2013–04–11
  14. By: Leppälä, Samuli (Cardiff Business School)
    Abstract: Arrow's information paradox asserts that demand for undisclosed information is undefined. Reassessing the paradox, I argue that the value of information for the buyer depends on its relevance, which can be known ex ante, and the uncertainty shifts to the capability of the seller to acquire the knowledge and her reliability in disclosing it. These three together form the buyer’s reservation price. Consequently, differences in capability and reliability between the sellers may revoke the appropriation problem of nonproprietary information, where the original source loses her monopoly after the first purchase.
    Keywords: Arrow’s information paradox; markets for information; knowledge; reliability; appropriability
    JEL: D83 L15 O31 O34
    Date: 2013–02
  15. By: Daniel Laskar (EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris, PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - École des Hautes Études en Sciences Sociales [EHESS] - Ecole des Ponts ParisTech - Ecole normale supérieure de Paris - ENS Paris - Institut national de la recherche agronomique (INRA))
    Abstract: We use a non-Bayesian approach to uncertainty which allows for both optimism and pessimism in a simple global game, where each signal can exhibit a bias which is ambiguous. We underline a symmetry between two models of financial crises: a liquidity crisis model, and a currency crisis model. We show that one model with pessimism becomes similar to the other model with optimism, and vice versa, which leads ambiguity to have opposite effects in the two models. We can also rationalize non-neutral effects of shifts in "market sentiment" in these models.
    Keywords: Persistence ; Global game ; Financial crises ; Ambiguity ; Optimism ; Pessimism ; Market sentiment ; Coordination
    Date: 2013–04

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