nep-mic New Economics Papers
on Microeconomics
Issue of 2013‒06‒24
nineteen papers chosen by
Jing-Yuan Chiou
IMT Lucca Institute for Advanced Studies

  1. Wondering How Others Interpret It: Social Value of Public Information By Alia Gizatulina
  2. A Formal Theory of Firm Boundaries: A Trade-Off between Rent Seeking and Bargaining Costs By Yusuke Mori
  3. Banking, Liquidity and Bank Runs in an Infinite-Horizon Economy By Mark Gertler; Nobuhiro Kiyotaki
  4. Auctions with imperfect commitment when the reserve may signal the auctioneer's type By Jun, Byoung Heon; Wolfstetter, Elmar G.
  5. All-Pay Auctions with Polynomial Rewards By Bos, Olivier; Ranger, Martin
  6. Political Economy in a Changing World By Daron Acemoglu; Georgy Egorov; Konstantin Sonin
  7. The Dynamics of Bertrand Price Competition with Cost-Reducing Investments By Fedor Iskhakov; John Rust; Bertel Schjerning
  8. Committee Design with Endogenous Participation By Volker Hahn
  9. Costly Monitoring, Dynamic Incentives, and Default By Gaetano Antinolfi
  10. (Ir)Rational Exuberance: Optimism, Ambiguity and Risk By Anat Bracha; Donald J. Brown
  11. Balancing the Power to Appoint Officers By Salvador Barberà; Danilo Coelho
  12. Modeling the Evolution of Expectations and Uncertainty in General Equilibrium By Francesco Bianchi; Leonardo Melosi
  13. Two-Person Fair Division of Indivisible Items: An Efficient, Envy-Free Algorithm By Brams, Steven J.; Kilgour, D. Marc; Klamler, Christian
  14. Selling Substitute Goods to Loss-Averse Consumers: Limited Availability, Bargains and Rip-offs By Rosato, Antonio
  15. Coase Revisited: Economic Efficiency under Externalities, Transaction Costs and Non-Convexity By Chavas, Jean-Paul
  16. On the geometry of luxury By A. Mantovi
  17. Traceability in a Supply Chain with Repeated Double Moral Hazard By Saak, Alexander E.
  18. Bank Bonuses and Bail-Outs By Hendrik Hakenes; Isabel Schnabel
  19. Price-Matching leads to the Cournot Outcome By Norovsambuu Tumennasan; Mongoljin Batsaikhan

  1. By: Alia Gizatulina (Max Planck Institute for Research on Collective Goods, Bonn)
    Abstract: This paper studies the social value of public information in environments without common knowledge of the data-generating process. We show that the stronger the coordination motive behind agents’ behaviour is, the more they use private or public signals in the way that they suspect others are doing it. Consequently, the negative impact of public communication noted by Morris and Shin (2002) can be amplified if agents suspect that others take the public signal too literally and/or are too inattentive to their private signals. Social welfare, if measured as in Morris and Shin (2002), always increases in the precision of the public signal when each agent evaluates its precision correctly, but believes that others did not understand the public signal at all, which suggests that there is a scope to “obliterate” public communication in a specific way, by making it, e.g., sophisticated and technical. By contrast, measuring welfare as in Woodford (2005) reverses, in general, desirability for such obliteration and non-commonality of signals’ understanding.
    Keywords: transparency, central bank communication, common p-belief, coordination game, higher-order uncertainty
    JEL: D82 E58
    Date: 2013–04
  2. By: Yusuke Mori (Research Fellow of Japan Society for the Promotion of Science, Institute of Social Science, The University of Tokyo, JAPAN)
    Abstract: We develop a theory of firm boundaries in the spirit of transaction cost analysis, in which trading parties engage in ex post value split. We show that ex post inefficient bargaining under non-integration creates a trade-off between rent seeking and bargaining costs: while non-integration incurs lower rent-seeking costs than integration, it suffers from bargaining delay and breakdown, which never occur under integration. This result explains why rent-seeking activities within firms are likely to be more costly than those between firms, and offers a formal justification for the "costs of bureaucracy" in Williamson (1985).
    Date: 2013–06
  3. By: Mark Gertler; Nobuhiro Kiyotaki
    Abstract: We develop a variation of the macroeconomic model with banking in Gertler and Kiyotaki (2011) that allows for liquidity mismatch and bank runs as in Diamond and Dybvig (1983). As in Gertler and Kiyotaki, because bank net worth fluctuates with aggregate production, the spread between the expected rates of return on bank assets and deposits fluctuates counter-cyclically. However, because bank assets are less liquid than deposits, bank runs are possible as in Diamond and Dybvig. Whether a bank run equilibrium exists depends on bank balance sheets and an endogenously determined liquidation price for bank assets. While in normal times a bank run equilibrium may not exist, the possibility can arise in a recession. We also analyze the effects of anticipated bank runs. Overall, the goal is to present a framework that synthesizes the macroeconomic and microeconomic approaches to banking and banking instability.
    JEL: E44
    Date: 2013–06
  4. By: Jun, Byoung Heon; Wolfstetter, Elmar G.
    Abstract: If bidders are uncertain whether the auctioneer sticks to the announced reserve, some bidders respond by not bidding, speculating that the auctioneer may revoke the reserve. However, the reserve inadvertently signals the auctioneer's type, which drives a unique separating and a multitude of pooling equilibria. If one eliminates belief systems that violate the "intuitive criterion", one obtains a unique equilibrium reserve price equal to the seller's own valuation. Paradoxically, even if bidders initially believe that the auctioneer is bound by his reserve almost with certainty, commitment has no value.
    Keywords: Auctions; signalling; mechanism design
    JEL: D21 D43 D44 D45
    Date: 2013–06–18
  5. By: Bos, Olivier; Ranger, Martin
    Abstract: This paper examines a perfectly discriminating contest (all-pay auction) with two asymmetric players. We focus on unordered valuations. Valuations are endogenous (polynomial functions) and depend on the effort each player invests in the contest. The shape of the valuation function is common knowledge and differs between the contestants. Some key properties of R&D races, lobbying activity and sport contests are captured by this framework. After analyzing the unique mixed strategy equilibrium, we derive a closed form of the expected expenditure of both players. We characterize the expected expenditure by means of incomplete Beta functions.
    Keywords: All-pay auctions, contests
    JEL: D44 D72
    Date: 2013–05–11
  6. By: Daron Acemoglu; Georgy Egorov; Konstantin Sonin
    Abstract: We provide a general framework for the analysis of the dynamics of institutional change (e.g., democratization, extension of political rights or repression of different groups), and how these dynamics interact with (anticipated and unanticipated) changes in the distribution of political power and in economic structure. We focus on the Markov Voting Equilibria, which require that economic and political changes should take place if there exists a subset of players with the power to implement such changes and who will obtain higher expected discounted utility by doing so. Assuming that economic and political institutions as well as individual types can be ordered, and preferences and the distribution of political power satisfy natural “single crossing” (increasing differences) conditions, we prove the existence of a pure-strategy equilibrium, provide conditions for its uniqueness, and present a number of comparative static results that apply at this level of generality. We then use this framework to study the dynamics of political rights and repression in the presence of radical groups that can stochastically grab power. We characterize the conditions under which the presence of radicals leads to repression (of less radical groups), show a type of path dependence in politics resulting from radicals coming to power, and identify a novel strategic complementarity in repression.
    JEL: C71 D71 D74
    Date: 2013–06
  7. By: Fedor Iskhakov (CEPAR, University of New South Wales); John Rust (Georgetown University); Bertel Schjerning (University of Copenhagen)
    Abstract: We present a dynamic extension of the classic static model of Bertrand price competition that allows competing duopolists to undertake cost-reducing investments in an attempt to “leapfrog” their rival to attain low-cost leadership—at least temporarily. We show that leapfrogging occurs in equilibrium, resolving the Bertrand investment paradox., i.e. leapfrogging explains why firms have an ex ante incentive to undertake cost-reducing investments even though they realize that simultaneous investments to acquire the state of the art production technology would result in Bertrand price competition in the product market that drives their ex post profits to zero. Our analysis provides a new interpretation of “price wars”. Instead of constituting a punishment for a breakdown of tacit collusion, price wars are fully competitive outcomes that occur when one firm leapfrogs its rival to become the new low cost leader. We show that the equilibrium involves investment preemption only when the firms invest in a deterministically alternating fashion and technological progress is deterministic. We prove that when technological progress is deterministic and firms move in an alternating fashion, the game has a unique Markov perfect equilibrium. When technological progress is stochastic or if firms move simultaneously, equilibria are generally not unique. Unlike the static Bertrand model, the equilibria of the dynamic Bertrand model are generally inefficient. Instead of having too little investment in equilibrium, we show that duopoly investments generally exceed the socially optimum level. Yet, we show that when investment decisions are simultaneous there is a “monopoly” equilibrium when one firm makes all the investments, and this equilibrium is efficient. However, efficient non-monopoly equilibria also exist, demonstrating that it is possible for firms to achieve efficient dynamic coordination in their investments while their customers also benefit from technological progress in the form of lower prices.
    Keywords: duopoly, Bertrand-Nash price competition, Bertrand paradox, Bertrand investment paradox, leapfrogging, cost-reducing investments, technological improvement, dynamic models of competition, Markov-perfect equilibrium, tacit collusion, price wars, coordination and anti-coordination games, strategic preemption
    JEL: D92 L11 L13
    Date: 2013–03–15
  8. By: Volker Hahn (Department of Economics, University of Konstanz, Germany)
    Abstract: We investigate the optimal design of a committee in a model with the endogenous participation of experts who have private information about their own abilities. We study three different dimensions of committee design: members' wages, the number of seats, and the communication system. We show that, surprisingly, higher wages lead to lower quality experts. By contrast, transparency improves the quality of experts on the committee. We provide a complete characterization of optimal committees. They are characterized by low wages and can be transparent or opaque. An increase in the significance of the decision requires a larger optimal committee, but does not call for different wages or for another communication system. Finally, we prove that the optimal committee design represents the best possible mechanism for the principal.
    Keywords: Committee decision-making, information aggregation, adverse selection, efficiency wages, transparency, career concerns
    JEL: D71 D82 J45
    Date: 2013–06–12
  9. By: Gaetano Antinolfi (Washington University)
    Abstract: We study dynamic contracts between a lender and a borrower in the presence of costly state verification and hidden effort. The optimal contract minimizes social losses by mediating dynamic incentives and monitoring. Along the efficiency frontier, the threat of early termination is unavoidable for low levels of the borrower's promised utility; as the level increases, preventive monitoring is used to avoid future inefficient termination of the contractual relationship due to asymmetric information; for high level of promised utility, the threat of termination of the contractual relationship is no longer a useful tool to align dynamic incentives, preventive monitoring loses its role, and termination never occurs. Thus, the efficient contract optimizes the tradeoff between dynamic incentives and static incentives. Following the interpretation of the costly state verification literature, we can distinguish two levels of bankruptcy: one that leads to monitoring and the other that leads to liquidation.
    Date: 2012
  10. By: Anat Bracha (Federal Reserve Bank of Boston); Donald J. Brown (Dept. of Economics, Yale University)
    Abstract: The equilibrium prices in asset markets, as stated by Keynes (1930): "...will be fixed at the point at which the sales of the bears and the purchases of the bulls are balanced." We propose a descriptive theory of finance explicating Keynes' claim that the prices of assets today equilibrate the optimism and pessimism of bulls and bears regarding the payoffs of assets tomorrow. This equilibration of optimistic and pessimistic beliefs of investors is a consequence of investors maximizing Keynesian utilities subject to budget constraints defined by market prices and investor's income. The set of Keynesian utilities is a new class of non-expected utility functions representing the preferences of investors for optimism or pessimism, defined as the composition of the investor's preferences for risk and her preferences for ambiguity. Bulls and bears are defined respectively as optimistic and pessimistic investors. (Ir)rational exuberance is an intrinsic property of asset markets where bulls and bears are endowed with Keynesian utilities.
    Keywords: Keynes, Bulls and bears, Expectations, Asset markets
    JEL: D81 G11
    Date: 2013–06
  11. By: Salvador Barberà; Danilo Coelho
    Abstract: Rules of k names are frequently used methods to appoint individuals to office. They are two-stage procedures where a first set of agents, the proposers, select k individuals from an initial set of candidates, and then another agent, the chooser, appoints one among those k in the list. In practice, the list of k names is often arrived at by letting each of the proposers screen the proposed candidates by voting for v of them and then choose those k with the highest support. We then speak of v-rules of k names. Our main purpose in this paper is to study how different choices of the parameters v and k affect the balance of power between the proposers and the choosers. From a positive point of view, we analyze a strategic game where the proposers interact to determine what list of candidates to submit. From a normative point of view, we study the performance of different rules in expected terms, under different informational assumptions. The choice of v and k is then analyzed from the perspectives of efficiency, fairness and compromise.
    Keywords: voting rules, constitutional design, Strong Nash equilibrium, rule of k names
    JEL: D02 D71 D72
    Date: 2013–05
  12. By: Francesco Bianchi; Leonardo Melosi
    Abstract: This paper develops methods to study the evolution of agents' expectations and uncertainty in general equilibrium models. A central insight consists of recognizing that the evolution of agents' beliefs can be captured by defining a set of regimes that are characterized by the degree of agents' pessimism, optimism, and uncertainty about future equilibrium outcomes. Once this kind of structure is imposed, it is possible to create a mapping between the evolution of agents' beliefs and observable outcomes. Agents in the model are fully rational, conduct Bayesian learning, and they know that they do not know. Therefore, agents form expectations taking into account that their beliefs will evolve according to what they observe in the future. The new modeling framework accommodates both gradual and abrupt changes in agents' beliefs and allows an analytical characterization of uncertainty. Shocks to beliefs are shown to have both first-order and second-order effects. To illustrate how to apply the methods, we use a prototypical Real Business Cycle model in which households form beliefs about the likely duration of high-growth and low-growth regimes.
    Keywords: Markov switching DSGE model, Bayesian econometrics, beliefs, uncertainty, Bayesian learning, rational expectations
    JEL: D83 E52 E52
    Date: 2013
  13. By: Brams, Steven J.; Kilgour, D. Marc; Klamler, Christian
    Abstract: Many procedures have been suggested for the venerable problem of dividing a set of indivisible items between two players. We propose a new algorithm (AL), related to one proposed by Brams and Taylor (BT), which requires only that the players strictly rank items from best to worst. Unlike BT, in which any item named by both players in the same round goes into a “contested pile,” AL may reduce, or even eliminate, the contested pile, allocating additional or more preferred items to the players. The allocation(s) that AL yields are Pareto-optimal, envy-free, and maximal; as the number of items (assumed even) increases, the probability that AL allocates all the items appears to approach infinity if all possible rankings are equiprobable. Although AL is potentially manipulable, strategizing under it would be difficult in practice.
    Keywords: Two-person fair division, indivisible items, envy-freeness, efficiency, algorithm
    JEL: C7 C78 D6 D61 D63 D7 D74
    Date: 2013–06
  14. By: Rosato, Antonio
    Abstract: Why are some sale items subject to limited availability while other substitute items are available in large quantities and are priced relatively high at the same point in time? Can such a retail strategy lure consumers into purchasing the more expensive item? This paper characterizes the profit-maximizing pricing and product-availability strategies for a retailer selling two substitute goods to loss-averse consumers and shows that limited-availability sales can manipulate consumers into an ex-ante unfavorable purchase. Consumers have unit demand, are interested in buying only one good, and their reference point is given by their recent rational expectations about what consumption value they would receive and what price they would pay. The seller maximizes profits by raising the consumers' reference point through a tempting discount on a good available only in limited supply (the bargain) and cashing in with a high price on the other good (the rip-off), which the consumers buy if the bargain is not available to minimize their disappointment. The seller might prefer to offer a deal on the more valuable product, using it as a bait, because consumers feel a larger loss, in terms of forgone consumption, if this item is not available. I also show that the bargain item can be a loss leader, that the seller's product line is not welfare-maximizing and that she might supply a socially wasteful product. The model suggests that the current FTC Guides Against Bait Advertising, by allowing retailers to employ limited-availability sales, could reduce consumer and social welfare.
    Keywords: Retail Pricing; Reference-Dependent Preferences; Loss Aversion; Limited Availability; Bait and Switch; Loss Leaders.
    JEL: D11 D42 L11
    Date: 2013
  15. By: Chavas, Jean-Paul
    Abstract: This paper presents a general equilibrium analysis of economic efficiency under externalities, transaction costs and non-convexity. It applies to market exchange as well as contractual arrangements. We show that the Coase theorem continues to hold under general conditions: the efficient management of externalities remains consistent with aggregate profit maximization under transaction costs and non-convexity. We examine the role of transaction costs and explore how the minimization of transaction costs is an integral part of efficient allocations. We also show how our analysis applies under non-convex technology, provided that we allow for non-linear pricing in markets.
    Keywords: Coase theorem, externalities, transaction costs, non-convexity, Pareto efficiency, Institutional and Behavioral Economics, Political Economy, Public Economics, B4, D5, D6,
    Date: 2013
  16. By: A. Mantovi
    Abstract: A 2-parameter class of ordinal utility functions over a pair of goods is discussed with respect to general traits of preferences for luxury. The class contains Cobb-Douglas functions as no-luxury limit; its analytical tractability is probed by simple closed form solutions for Marshallian demand functions, expansion paths, Engel curves, income elasticity of demand, saturation levels, elasticity of substitution. Following Mantovi (2013), scale and substitution effects can be represented in terms of flows on bundle space; departure from homotheticity can thereby be represented by an index of luxury which measures the noncommutativity of such effects. On conceptual grounds, our index is intimately connected with Shephard’s distance. Decompositions of productive efficiency as tailored by Bogetoft et al. (2006) represent a natural setting for the application of our approach.
    Keywords: Duality, homotheticity, Cobb-Douglas function, luxury, expansion path, elasticity of substitution, scale effect, substitution effect, income effect, Shephard’s distance
    JEL: D11 D81 E21
    Date: 2013
  17. By: Saak, Alexander E.
    Abstract: Recent food safety events have raised concerns about adoption of traceability systems. The paper studies the question of when and why a supply chain should invest in an upstream traceability system that allows identifying which supplier is responsible for quality defects due to insufficient (non-contractible) effort when firms interact repeatedly. The downstream firm and consumers observe imperfect, lagged signals of input and output quality. Without appealing to exogenous cost for a traceability system, it is demonstrated that in deciding whether to maintain information regarding product origin, firms face a trade-off. On one hand, the downstream firm is tempted to condone limited upstream shirking or resort to an experimentation strategy to identify the upstream shirker when products are not traceable to their firm of origin. On the other hand, the downstream firm is tempted to “vertically coordinate” shirking in the provision of quality when products are traceable. Colluding with a subset of upstream firms is more attractive when the downstream firm can tell whether a product originates from a shirking or non-shirking firm. Firms achieve greater joint profits when products are not traceable to upstream suppliers if (1) the ratio of the cost savings from upstream shirking and downstream shirking is neither too large nor too small or (2) the probability with which the downstream firm detects input defects is not too large or (3) the consumer experience is a sufficiently noisy signal of quality. It is also shown that the returns to more precise inter-firm monitoring can increase or decrease after the adoption of a traceability system depending on information generated by consumer experience.
    Keywords: Food Consumption/Nutrition/Food Safety, Industrial Organization,
    Date: 2013
  18. By: Hendrik Hakenes (University of Bonn, Finance Department); Isabel Schnabel (Gutenberg School of Management and Economics, Johannes Gutenberg University Mainz)
    Abstract: This paper shows that bonus contracts may arise endogenously as a response to agency problems within banks, and analyzes how compensation schemes change in reaction to anticipated bail-outs. If there is a risk-shifting problem, bail-out expectations lead to steeper bonus schemes and even more risk-taking. If there is an effort problem, the compensation scheme becomes flatter and effort decreases. If both types of agency problems are present, a sufficiently large increase in bailout perceptions makes it optimal for a welfare-maximizing regulator to impose caps on bank bonuses. In contrast, raising managers’ liability can be counterproductive.
    Keywords: bonus payments, bank bail-outs, bank management compensation, risk-shifting, underinvestment, limited and unlimited liability
    JEL: J33 G21 G28 M52
    Date: 2013–02
  19. By: Norovsambuu Tumennasan (Department of Economics and Business, Aarhus University); Mongoljin Batsaikhan (Georgetown University)
    Abstract: We study the effects of price-matching in a duopoly setting in which each firm selects both its price and output, simultaneously. We show that the availability of a pricematching option leads to the Cournot outcome in this setting. This result is a stark contrast to the one obtained in the standard Bertrand competition that the market price in the presence of a price-matching option ranges from the monopolistic price to the Bertrand price. Our result suggests that the effect of price-matching depends on whether the output is a choice variable for the firms.
    Keywords: Price matching
    JEL: L00 D4
    Date: 2013–06–18

This nep-mic issue is ©2013 by Jing-Yuan Chiou. 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.