nep-mic New Economics Papers
on Microeconomics
Issue of 2015‒12‒08
23 papers chosen by
Jing-Yuan Chiou
National Taipei University

  1. Optimal Dynamic Contracting: the First-Order Approach and Beyond By Battaglini, Marco; Lamba, Rohit
  2. Evidence Games : Truth and Commitment By Hart, Sergiu; Kremer, Ilan; Perry, Motty
  3. Resource allocation in the brain By Ricardo Alonso; Isabelle Brocas; Juan D. Carrillo
  4. A Characterization of Risk-Neutral and Ambiguity-Averse Behavior By Gerasimou, Georgios
  5. The Threat of Corruption and the Optimal Supervisory Task By Alessandro De Chiara; Luca Livio
  6. Rational Expectations and Farsighted Stability By Dutta, Bhaskar; Vohra, Rajiv
  7. Charity Auctions for the Happy Few By Bos, Olivier
  8. Gorman Revisited: Nonparametric Conditions for Exact Linear Aggregation By Laurens Cherchye; Ian Crawford; Bram De Rock; Frederic Vermeulen
  9. Stochastic Stability in a Learning Dynamic with Best Response to Noisy Play By Christopher Kah; Markus Walzl
  10. Endogeneous Quantal Response Equilibrium for Normal Form Games By Oswaldo Gressani
  11. Imperfect Certification under Cournot Duopoly By Charu Grover; Sangeeta Bansal
  12. On Random Social Choice Functions with the Tops-only Property By Shurojit Chatterji; Huaxia Zeng
  13. Optimal influence under observational learning By Nikolas Tsakas
  14. On Stable and Strategy-Proof Rules in Matching Markets with Contracts By HIRATA, Daisuke; KASUYA, Yusuke
  15. Price Instability in Multi-Unit Auctions By Anderson, Edward; Holmberg, Pär
  16. Identity-Based Organizations By Jean-Paul Carvalho
  17. Reference Points and Learning By Alan Beggs
  18. Sacrifice and Sorting in Clubs By Jean-Paul Carvalho
  19. Decision making in times of uncertainty: An info-gap perspective By Yakov Ben-Haim; Maria Demertzis
  20. Transitivity of Preferences: When Doest it Matter ? By Laurens Cherchye; Thomas Demuynck; Bram De Rock
  21. Endogenous Market Making and Network Formation By Briana Chang; Shengxing Zhang
  22. Civil Liability, Knight’s Uncertainty and Non-Dictatorial Regulator By Gérard Mondello
  23. Equilibrium Default By Manuel Amador; Ivan Werning; Hugo A. Hopenhayn; Mark Aguiar

  1. By: Battaglini, Marco; Lamba, Rohit
    Abstract: We study a dynamic principal-agent model in which the agent's types are serially correlated. In these models, the standard approach consists of first solving a relaxed version in which only local incentive compatibility constraints are considered, and then in proving that the local constraints are sufficient for implementability. We explore the conditions under which this approach is valid and can be used to characterize the profit maximizing contract. We show that the approach works when the optimal allocation in the relaxed problem is monotonic in the types, a condition that is satisfied in most solved examples. Contrary to the static model, however, monotonicity is generally violated in many interesting economic environments. Moreover, when the time horizon is long enough and serial correlation is sufficiently high, global incentive compatibility constraints are generically binding. By fully characterizing a simple two period example, we uncover a number of interesting features of the optimal contract that cannot be observed in spatial environments in which the standard approach works. Finally, we show that even in complex environments, approximately optimal allocations can be easily characterized by focusing on a particular class of contracts in which the allocation is forced to be monotonic.
    Keywords: contract theory; dynamic contracts
    JEL: D86
    Date: 2015–11
  2. By: Hart, Sergiu (Department of Economics, Institute of Mathematics, and Federmann Center for the Study of Rationality, The Hebrew University of Jerusalem.); Kremer, Ilan (Department of Economics, Business School, and Federmann Center for the Study of Rationality, The Hebrew University of Jerusalem; Department of Economics, University of Warwick); Perry, Motty (Federmann Center for the Study of Rationality, The Hebrew University of Jerusalem; Department of Economics, University of Warwick.)
    Abstract: An evidence game is a strategic disclosure game in which an informed agent who has some pieces of verifiable evidence decides which ones to disclose to an uninformed principal who chooses a reward. The agent, regardless of his information, prefers the reward to be as high as possible. We compare the setup where the principal chooses the reward after the evidence is disclosed to the mechanism-design setup where he can commit in advance to a reward policy. The main result is that under natural conditions on the truth structure of the evidence, the two setups yield the same equilibrium outcome.
    Date: 2015
  3. By: Ricardo Alonso; Isabelle Brocas; Juan D. Carrillo
    Abstract: When an individual performs several tasks simultaneously, processing resources must be allocated to different brain systems to produce energy for neurons to fire. Following the evidence from neuroscience, we model the brain as an organization in which a coordinator allocates limited resources to the brain systems responsible for the different tasks. Systems are privately informed about the amount of resources necessary to perform their task and compete to obtain the resources. The coordinator arbitrates the demands while satisfying the resource constraint. We show that the optimal mechanism is to impose to each system with privately known needs a cap in resources that depends negatively on the amount of resources requested by the other system. This allocation can be implemented using a biologically plausible mechanism. Finally, we provide some implications of our theory: (i) performance can be flawless for sufficiently simple tasks, (ii) the dynamic allocation rule exhibits inertia (current allocations are increasing in past needs), and (iii) different cognitive tasks are performed by different systems only if the tasks are sufficiently important.
    Keywords: Mechanism design; Revelation principle; Neuroeconomic theory; Resource allocation; Multiple brain systems; Task inertia; Neural Darwinism
    JEL: D71 D82
    Date: 2014
  4. By: Gerasimou, Georgios
    Abstract: This paper studies a decision maker who chooses monetary bets/investment portfolios under pure uncertainty. Necessary and sufficient conditions on his preferences over these objects are provided for his choice behavior to be guided by the *maxmin expected value* rule, and therefore to exhibit both ``risk neutrality'' and ambiguity aversion. This result is obtained as an extension of a simple re-characterization of de Finetti's theorem on maximization of subjective expected value.
    Keywords: Maxmin expected value; ambiguity aversion; risk neutrality; multiple priors; de Finetti.
    JEL: D01 D03 D11
    Date: 2015–12–01
  5. By: Alessandro De Chiara; Luca Livio
    Abstract: In this paper we investigate the task the supervisor should be optimally charged with in an agency modelin which the principal faces corruption concerns. We highlight a fundamental tradeoff between monitoringthe agent’s effort choice and auditing it ex-post. Monitoring proves more effective in tackling corruptionsince the supervisor sends the report before the profit realization. By taking advantage of the supervisor’suncertainty about the state of nature, the principal can design a compensation scheme which prevents allforms of corruption at a lower cost. Conversely auditing reduces the cost of supervision as the principalhires the supervisor only if the profit does not convey enough information about the compensation due tothe agent. We show that the ultimate choice between monitoring and auditing depends on the supervisor’sability to falsify information and the cost of performing an inspection.
    Keywords: auditing; collusion; corruption; extortion; monitoring; supervision
    JEL: D82 D86 L22
    Date: 2015–10
  6. By: Dutta, Bhaskar (University of Warwick); Vohra, Rajiv (Brown University)
    Abstract: In the study of farsighted coalitional behavior, a central role is played by the von Neumann-Morgenstern (1944) stable set and its modification that incorporates farsightedness. Such a modification was first proposed by Harsanyi (1974) and has recently been re-formulated by Ray and Vohra (2015). The farsighted stable set is based on a notion of indirect dominance in which an outcome can be dominated by a chain of coalitional ‘moves’ in which each coalition that is involved in the sequence eventually stands to gain. However, it does not require that each coalition make a maximal move, i.e., one that is not Pareto dominated (for the members of the coalition in question) by another. Nor does it restrict coalitions to hold common expectations regarding the continuation path from every state. Consequently, when there are multiple continuation paths the farsighted stable set can yield unreasonable predictions. We resolve this difficulty by requiring all coalitions to have common rational expectations about the transition from one outcome to another. This leads to two related concepts: the rational expectations farsighted stable set (REFS) and the strong rational expectations farsighted stable set (SREFS). We apply these concepts to simple games and to pillage games to illustrate the consequences of imposing rational expectations for farsighted stability.
    Keywords: stable sets ; farsightedness ; consistency ; maximality ; rational expectations ; simple games ; pillage games. JEL Classification Numbers: C71 ; D72 ; D74
    Date: 2015
  7. By: Bos, Olivier
    Abstract: Recent literature has shown that all-pay auctions raise more money for charity than either winner-pay auctions or lotteries. We demonstrate that first-price and second-price winner- pay auctions have a better revenue performance than first-price and second-price all-pay auctions when bidders are sufficiently asymmetric. Lotteries can also provide higher revenue than all-pay auctions. To prove this, we consider a framework with complete information. Complete information is helpful and may reflect events that occur, for instance, in a local service club (such as a voluntary organization) or at a show-business dinner.
    Keywords: All-pay auctions, charity, complete information, externalities
    JEL: D44 D62 D64
    Date: 2015–12–01
  8. By: Laurens Cherchye; Ian Crawford; Bram De Rock; Frederic Vermeulen
    Abstract: In the tradition of Afriat (1967), Diewert (1973) and Varian (1982), we provide arevealed preference characterisation of exact linear aggregation. This guarantees thataggregate demand can be written as a function of prices and aggregate income alone,while abstracting from income-distributional aspects. We also establish nonparametricconditions for individual consumption to be representable in terms of Gorman PolarForm preferences. Our results are simple and complement those of Gorman (1953,1961). We illustrate the practical usefulness of our results by means of an empiricalapplication to a Spanish balanced microdata panel.
    Date: 2015–11
  9. By: Christopher Kah; Markus Walzl
    Abstract: We propose a learning dynamic with agents using samples of past play to estimate the distribution of other players’ strategy choices and best responding to this estimate. To account for noisy play, estimated distributions over other players’ strategy choices have full support in the other players’ strategy sets for positive levels of noise and converge to the sampled distribution in the limit of vanishing noise. Recurrent classes of the dynamic process only contain admissible strategies and can be characterised by minimal CURB sets based on best responses to noisy play whenever the set of sampled distributions is sufficiently rich. In this case, the dynamic process will always end up in a set of strategies that contains the support of a (trembling hand) perfect equilibrium. If the perfect equilibrium is unique and in pure strategies, the equilibrium resembles the unique recurrent class of the dynamic process. We apply the dynamic process to learning in matching markets and sequential two player games with perfect information.
    Keywords: Best-response learning, equilibrium selection, stochastic stability, trembling hand perfection, CURB sets
    JEL: C72 C73 D83
    Date: 2015–11
  10. By: Oswaldo Gressani (CREA, Université de Luxembourg)
    Abstract: We develop an equilibrium concept coined Endogeneous Quantal Response Equilibrium (EQRE) based on heterogeneous players and endogeneous learning in a logistic quantal choice model. Each player has an asymptotically consistent estimate of his rival's rationality index and is able to choose his own rationality level according to a cost-benefit tradeoff This approach allows to enrich bounded rationality models by incorporating heterogeneous skills and by bridging the gap between stylized facts on the rationality index dynamics and a learning dimension.
    Keywords: Quantal Response Equilibrium, bounded rationality, learning
    Date: 2015
  11. By: Charu Grover (Centre for International Trade and Development,Jawaharlal Nehru University); Sangeeta Bansal (Centre for International Trade and Development,Jawaharlal Nehru University)
    Abstract: Environmental quality is often a credence good and consumers are unable to distinguish between green and brown products. The paper aims to investigate the role of certification in providing information about product quality and reducing market inefficiencies when the certification process is imperfect. We consider a duopoly in a vertically differentiated product model where firms compete in quantities. The papers shows that in the absence of labelling, the brown firm drives out the green firm if the cost of producing green product is sufficiently high. If both firms produce positive quantities in the market, the green firm covers a higher market share and obtains larger revenue. We then characterise pooling and separating equilibrium under imperfect certification contingent on certification fee. The paper shows that under imperfect certification, it is not optimal to subsidize certification.
  12. By: Shurojit Chatterji (Singapore Management University); Huaxia Zeng (Singapore Management University)
    Abstract: We study the standard voting model with randomization. A Random Social Choice Function (or RSCF) satisfies the tops-only property if the social lottery under each preference profile depends only on voters' peaks of preferences. We identify a general condition on domains of preferences (the Interior Property and the Exterior Property) which ensures that every strategy-proof RSCF satisfying unanimity has the tops-only property. We provide applications of this sufficient condition and use it to derive new results.
    Date: 2015–09
  13. By: Nikolas Tsakas
    Abstract: We study the optimal targeting problem of a firm that seeks to maximize the diffusion of a product in a society where agents learn from their neighbors. The firm can seed the product to a subset of the population and our goal is to find which is the optimal subset to target. We provide a condition that characterizes the optimal targeting strategy for any network structure. The key parameter in this condition is the agents' decay centrality, which takes into account how close an agent is to others, in a way that distant agents are weighted less than closer ones.
    Keywords: Social Networks; Targeting; Diffusion; Observational Learning
    JEL: D83 D85 H23 M37
    Date: 2015–12
  14. By: HIRATA, Daisuke; KASUYA, Yusuke
    Abstract: This paper studies stable and (one-sided) strategy-proof matching rules in many-to-one matching markets with contracts. First, the number of such rules is shown to be at most one. Second, the doctor-optimal stable rule, whenever it exists, is shown to be the unique candidate for a stable and strategy-proof rule. Third, a stable and strategy-proof rule, when exists, is shown to be second-best optimal for doctor welfare, in the sense that no individually-rational and strategy-proof rule can dominate it. This last result is further generalized to non-wasteful and strategy-proof rules. Notably, all those results are established without any substitutes conditions on hospitals' choice functions, and hence, the proofs do not rely on the "rural hospital" theorem. We also show by example that the outcomes of a stable and strategy-proof rule do not always coincide with those of the cumulative offer process; hence, the above results hold NOT because the cumulative offer process is the only candidate for stable and strategy-proof rules.
    Keywords: matching with contracts, stability, strategy-proofness, uniqueness, efficiency, irrelevance of rejected contracts
    Date: 2015–09–25
  15. By: Anderson, Edward (University of Sydney); Holmberg, Pär (Research Institute of Industrial Economics (IFN))
    Abstract: We consider a procurement auction, where each supplier has private costs and submits a stepped supply function. We solve for a Bayesian Nash equilibrium and show that the equilibrium has a price instability in the sense that a minor change in a supplier.s cost sometimes result in a major change in the market price. In wholesale electricity markets, we predict that the bid price of the most expensive production unit can change by 1-10% due to price instability. The price instability is reduced when suppliers have more steps in their supply functions for a given production technology. In the limit, as the number of steps increases and the cost uncertainty decreases, the Bayesian equilibrium converges to a pure-strategy NE without price instability, the Supply Function Equilibrium (SFE).
    Keywords: Multi-unit auctions; indivisible unit; price instability; Bayesian Nash equilibria; supply function equilibria; convergence of Nash equilibria; whole-sale electricity markets
    JEL: C62 C72 D43 D44 L94
    Date: 2015–11–27
  16. By: Jean-Paul Carvalho (Department of Economics, University of California-Irvine)
    Abstract: A single club model describes the collective production of both personal and social identity. Personal identity, how one perceives oneself, is formed through a process of cultural transmission. Social identity, how one is perceived by others, takes the form of collective reputation. Our model of identity-based organizations incorporates into the economics of identity insights from the economics of religion and cultural transmission. The identities that develop tend to be oppositional. Organizations devoted to more extreme identities are able to support higher levels of participation and collective action.
    Keywords: Identity; Club goods; Economics of religion; Cultural transmission
    JEL: Z12 J22 D03
    Date: 2015–12
  17. By: Alan Beggs
    Abstract: Abstract This paper studies learning when agents evaluate outcomes in comparison to a reference point. It shows that certain models of reinforcement learning lead toclasses of recursive preferences.
    Keywords: Reference points, Reinforcement Learning, Recursive Preferences
    JEL: D83 D87
    Date: 2015–11–20
  18. By: Jean-Paul Carvalho (Department of Economics, University of California-Irvine)
    Abstract: In club models of religion, sacrifices demanded by religious groups promote efficient production of club goods by screening out free riders. An alternative, complementary view is that religious clubs provide a means of sorting, matching individuals with similar characteristics. Sorting differs from screening in that it operates on traits that do not directly affect club goods production. This paper explores the role of sacrifice in sorting among religious clubs when individuals prefer to interact with their own type. Despite this own-type bias, the usual free- rider problem in club goods production can inhibit sorting among groups. Pro- hibitions and demands for stigmatizing behavior can solve this problem. Costly sacrifices are demanded, not by groups catering to the majority, but by those attracting rare/exotic types. The rarer the type, the more costly the sacrifice required to a chieve sorting.
    Keywords: Club goods,;Economics of religion; Sorting
    JEL: C72 C73 Z1
    Date: 2015–10
  19. By: Yakov Ben-Haim; Maria Demertzis
    Abstract: The distinction of risk vs uncertainty as made by Knight has important implications for policy selection. Assuming the former when the latter is relevant can lead to wrong decisions. With the aid of a stylized model that describes a bank's decision on how to allocate loans, we discuss decision making under Knightian uncertainty. We use the info-gap robust satisficing approach to derive a trade-off between confidence and performance (somewhat analogous to confidence intervals in the Bayesian approach but without assignment of probabilities). We then contrast how decisions change when following this approach by comparison to the other main non-probabilistic approach available in the literature, namely min-max.
    Keywords: Uncertainty vs risk; confidence; robustness; satisficing; info-gap
    JEL: C11 D81 G10
    Date: 2015–11
  20. By: Laurens Cherchye; Thomas Demuynck; Bram De Rock
    Abstract: We define the empirical conditions on prices and incomes under which transitivityof preferences has specific testable implications. In particular, we set out necessaryand sufficient requirements for budget sets under which consumption choices canviolate SARP (Strong Axiom of Revealed Preferences) but not WARP (Weak Axiomof Revealed Preferences). As SARP extends WARP by additionally imposingtransitive preferences, this effectively defines the conditions under which transitivityis separately testable. Our findings have considerable practical relevance, as transitivityconditions are known to substantially aggravate the computational burden ofempirical revealed preference analysis. Our characterization takes the form of triangularconditions that must hold for all three-element subsets of normalized prices,and which are easy to verify in practice. We demonstrate their practical use throughtwo short empirical applications.
    Keywords: revealed preferences; WARP; SARP; transitivity; testable implications
    JEL: C14 D01 D11 D12
    Date: 2015–11
  21. By: Briana Chang (School of Business, University of Wisconsin–Madison;); Shengxing Zhang (Department of Economics, London School of Economics (LSE); Centre for Macroeconomics (CFM))
    Abstract: This paper proposes a theory of intermediation in which intermediaries emerge endogenously as the choice of agents. In contrast to the previous trading models based on random matching or exogenous networks, we allow traders to explicitly choose their trading partners as well as the number of trading links in a dynamic framework. We show that traders with higher trading needs optimally choose to match with traders with lower needs for trade and they build fewer links in equilibrium. As a result, traders with the least trading need turn out to be the most connected and have the highest gross trade volume. The model therefore endogenously generates a core-periphery trading network that we often observe: a financial architecture that involves a small number of large, interconnected institutions. We use this framework to study bid-ask spreads, trading volume, asset allocation and implications on systemic risk.
    Keywords: Over-the-Counter Market, Trading Network, Matching, Intermediation
    JEL: C70 G1 G20
    Date: 2015–11
  22. By: Gérard Mondello (Université Nice Sophia Antipolis; GREDEG-CNRS)
    Abstract: This paper reviews the foundations of the unilateral standard accident model under Knightian uncertainty. It extends the Teitelbaum (2007)’s seminal article (who introduces radical uncertainty) by expanding it from producers to victims and from the probability distribution of accidents to the scale of damage. Mainly, it also considers a regulator who aggregates the agents’ preferences (Neghisi (1960) type). Under the condition that the troublemakers’ resources are sufficient to cover the damage, the article shows that uncertainty does not preclude, first, the determination of a socially optimal level of care, and second, whatever the civil liability regime (strict liability or negligence) it shows that they determine the same level of socially first-best care. The solution is inefficient only when the polluter’s wealth is insufficient to repair the victim’s losses.
    Keywords: unilateral accident, tort law, safety, large risks, ambiguity, pessimism and optimism, strict liability, negligence, ultra-hazardous activities
    JEL: D62 K13 K23 K32 Q52 Q58
    Date: 2015–12
  23. By: Manuel Amador (Federal Reserve Bank of Minneapolis); Ivan Werning (Massachusetts Institute of Technology); Hugo A. Hopenhayn (UCLA); Mark Aguiar (Princeton University)
    Abstract: This paper studies the optimal financing of an investment project subject to the risk of default. A project needs outside funding from a lender, but the borrower can walk away at any moment and take some outside opportunity. The value of this opportunity is random and not observable by the lender. We show that the optimal dynamic contract may allow default along the equilibrium path. Focusing on the dynamics of default, debt and capital accumulation, we find that over the life of the project the probability of default declines, long-term debt falls and capital rises
    Date: 2015

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