nep-mic New Economics Papers
on Microeconomics
Issue of 2017‒11‒19
24 papers chosen by
Jing-Yuan Chiou
National Taipei University

  1. Adverse Selection and Moral Hazard with Multidimensional Types By Suehyun Kwon
  2. Dynamic Principal–Agent Models By Philipp Renner; Karl Schmedders
  3. Market Power and Welfare in Asymmetric Divisible Good Auctions By Carolina Manzano; Xavier Vives
  4. Relational Contracts with Private Information on the Future Value of the Relationship: The Upside of Implicit Downsizing Costs By Matthias Fahn; Nicolas Klein
  5. Risk Aversion and Prudence in Contests By Marco Sahm
  6. Disputes, Debt and Equity By Alfred Duncan; Charles Nolan
  7. The Impact of Social Media On Belief Formation By Schwarz, Marco A.
  8. Information Exchange in Retail Markets with Uncertainty about Downstream Costs By Daniel Herold
  9. Consumer-Optimal Information Design By von Wangenheim, Jonas
  10. Compliance Programs, Signaling and Firms' Internal Coordination By Daniel Herold
  11. Mechanism Design with Moral Hazard By Suehuyn Kwon
  12. Mate Choice Mechanism for Solving a Quasi-Dilemma By Tatsuyoshi Saijo; Junyi Shen
  13. The Impact of Incentive Pay on Corporate Crime By Daniel Herold
  14. Pricing Advices By Suehyun Kwon
  15. Segmentation versus Agglomeration: Competition between Platforms with Competitive Sellers By Karle, Heiko; Peitz, Martin; Reisinger, Markus
  16. Subsidized Capacity Investment under Uncertainty By Wen, Xingang; Hagspiel, V.; Kort, Peter
  17. Optimal Cost Overruns: Procurement Auctions with Renegotiation By Herweg, Fabian; Schwarz, Marco A.
  18. Signaling to Experts By Pablo Kurlat; Florian Scheuer
  19. Nonconcave Robust Optimization under Knightian Uncertainty By Ariel Neufeld; Mario Sikic
  20. Price competition and limited attention By Karpov, Aleksandr
  21. How fragile are information cascades? By Yuval Peres; Miklos Z. Racz; Allan Sly; Izabella Stuhl
  22. Machine learning for dynamic incentive problems By Philipp Renner; Simon Scheidegger
  23. The effect of horizontal mergers, when firms compete in prices and investments By Motta, Massimo; Tarantino, Emanuele
  24. Optimal Favoritism in All-Pay Auctions and Lottery Contests By Jörg Franke; Wolfgang Leininger; Cédric Wasser

  1. By: Suehyun Kwon
    Abstract: This paper studies a contracting problem where agents’ cost of actions is private information. With two actions, this leads to a two-dimensional screening problem with moral hazard. There is a natural one-dimensional ordering of types when there is both adverse selection and moral hazard. Regardless of the number of types, an optimal menu of contracts either pools every type together or offers a menu of two contracts. Any incentive-compatible menu of contracts has to satisfy pairwise single-crossing properties in incentivized actions and ex-ante utilities. The principal can no longer sell the firm to the agent.
    Keywords: adverse selection, moral hazard, multidimensional types
    Date: 2017
  2. By: Philipp Renner; Karl Schmedders
    Abstract: This paper contributes to the theoretical and numerical analysis of discrete time dynamic principal-agent problems with continuous choice sets. We first provide a new and simplified proof for the recursive reformulation of the sequential dynamic principal-agent relationship. Next we prove the existence of a unique solution for the principal's value function, which solves the dynamic programming problem in the recursive formulation. By showing that the Bellman operator is a contraction mapping, we also obtain a convergence result for the value function iteration. To compute a solution for the problem, we have to solve a collection of static principal{agent problems at each iteration. Under the assumption that the agent's expected utility is a rational function of his action, we can transform the bi-level optimization problem into a standard nonlinear program. The final results of our solution method are numerical approximations of the policy and value functions for the dynamic principal-agent model. We illustrate our solution method by solving variations of two prominent social planning models from the economics literature.
    Keywords: Optimal unemployment tax, principal-agent model, repeated moral hazard
    JEL: C63 D80 D82
    Date: 2017
  3. By: Carolina Manzano; Xavier Vives
    Abstract: We analyze a divisible good uniform-price auction that features two groups each with a finite number of identical bidders. Equilibrium is unique, and the relative market power of a group increases with the precision of its private information but declines with its transaction costs. In line with empirical evidence, we find that an increase in transaction costs and/or a decrease in the precision of a bidding group.s information induces a strategic response from the other group, which thereafter attenuates its response to both private information and prices. A “stronger†bidding group -which has more precise private information, faces lower transaction costs, and is more oligopsonistic- has more market power and so will behave competitively only if it receives a higher per capita subsidy rate. When the strong group values the asset no less than the weak group, the expected deadweight loss increases with the quantity auctioned and also with the degree of payoff asymmetries. Market power and the deadweight loss may be negatively associated.
    Keywords: demand/supply schedule competition, private information, liquidity auctions, treasury auctions, electricity auctions
    JEL: D44 D82 G14 E58
    Date: 2016
  4. By: Matthias Fahn; Nicolas Klein
    Abstract: We analyze a relational contracting problem, in which the principal has private information about the future value of the relationship. In order to reduce bonus payments, the principal is tempted to claim that the value of the future relationship is lower than it actually is. To induce truth-telling, the optimal relational contract may introduce distortions after a bad report. For some levels of the discount factor, output is reduced by more than would be sequentially optimal. This distortion is attenuated over time even if prospects remain bad. Our model thus provides an alternative explanation for indirect short-run costs of downsizing.
    JEL: C73 D86
    Date: 2017
  5. By: Marco Sahm
    Abstract: I examine the impact of risk preferences on efforts and winning probabilities in generalised Tullock contests between two players. The theoretical analysis yields two main results. First, I specify a sufficient condition on the agents’ comparative prudence under which a higher common level of risk aversion leads to lower aggregate effort in symmetric contests. Second, I show that for a certain range of parameters in asymmetric contests, higher risk-aversion will be a disadvantage if the agent is comparatively prudent.
    Keywords: Tullock contest, risk aversion, prudence
    JEL: C72 D72
    Date: 2017
  6. By: Alfred Duncan; Charles Nolan
    Abstract: We show how the prospect of disputes over firms’ revenue reports promotes debt financing over equity. These findings are presented within a costly state verification model with a risk averse entrepreneur. The prospect of disputes encourages incentive contracts that limit penalties and avoid stochastic monitoring, even when the lender can commit to stochastic monitoring strategies. Consequently, optimal contracts shift away from equity and toward standard debt. For a useful special case of the model, closed form solutions are presented for leverage and consumption allocations under efficient debt contracts. Some empirical implications of the theory are pursued.
    Keywords: Microeconomics; costly state verification; external finance; leverage
    JEL: D52 D53 D82 D86
    Date: 2017–07
  7. By: Schwarz, Marco A. (University of Innsbruck)
    Abstract: Social media are becoming increasingly important in our society and change the way people communicate, how they acquire information, and how they form beliefs. Experts are concerned that the rise of social media may make interaction and information exchange among like-minded individuals more pronounced and therefore lead to increased disagreement in a society. This paper analyzes a learning model with endogenous network formation in which people have different types and live in different regions. I show that when the importance of social media increases, the amount of disagreement in the society first decreases and then increases. Simultaneously people of the same type hold increasingly similar beliefs. Furthermore, people who find it hard to communicate with people in the same region may interact with similar people online and consequently hold extreme beliefs. Finally, I propose a simple way to model people who neglect a potential correlation of signals and show that these people may be made worse off by social media.
    Keywords: social media; network formation; social learning; polarization; homophily; correlation neglect;
    JEL: C72 D72 D83 D85 Z10 Z19
    Date: 2017–11–09
  8. By: Daniel Herold (Justus-Liebig-University Giessen)
    Abstract: An information exchange between two producers selling independent products to the same retailer can have ambiguous effects on market efficiency and surplus. When a retailer's costs are unobservable the producers may have an incentive to communicate about their negotiations with that retailer. If each producer is allowed to place one offer the producers will have no incentive to exchange information. However, the retailer may communicate that he refused the first offer to the other firm which subsequently might place a lower offer. When one firm is allowed to place a second offer, two equilibria involve communication between the producers. In a separating equilibrium an information exchange ensures that agreement will always be found. In a hybrid equilibrium, the likelihood that agreement is found is less likely.
    JEL: L41 L42 L13
    Date: 2017
  9. By: von Wangenheim, Jonas (Humboldt University Berlin)
    Abstract: In many trade environments - such as online markets - buyers fully learn their valuation for goods only after contracting. I characterize the buyer-optimal ex-ante information in such environments. Employing a classical sequential screening framework, I find that buyers prefer to remain partially uninformed, since such an information structure induces the seller to set low prices. For the optimal information signal, trade is efficient, and the seller only extracts the static monopoly profit. Further, I fully characterize all possible surplus divisions that can arise in sequential screening for a given prior.
    Keywords: information disclosure; sequential screening; strategic learning; bayesian persuasion; mechanism design;
    JEL: D82
    Date: 2017–11–02
  10. By: Daniel Herold (Justus-Liebig-University Giessen)
    Abstract: Fines imposed on firms for corporate infringements such as cartels reduce these infringement's profitability. When a manager knows when a violation is unprofitable he can prevent violations committed by an uninformed employee by investing in compliance programs (CPs). Investments can be interpreted as signals. The paper shows that there exists a separating equilibrium where high investments in CPs induce the employee to obey the law. However, if CPs are too expensive the signal is not credible. The manager can also show personal commitment to compliance ('tone-at-the-top'). Coordination on an efficient outcome will then be achievable if commitment is costly. Imposing high, individual sanctions on the manager disturbs a firm's internal coordination because he is unable to credibly signal that an infringement does not pay off for the firm. However, imposing sanctions on the employee unambiguously deters violation.
    Keywords: Bitcoin, Compliance, Crime, Tone-at-the-top
    JEL: D82 D86 L14 L22 K20 K21
    Date: 2017
  11. By: Suehuyn Kwon
    Abstract: This paper studies dynamic mechanism design in the presence of moral hazard. Revelation principle extends to models with moral hazard for both full commitment and limited commitment, but I also identify environments in which the principal doesn’t benefit from eliciting agents’ private information or beliefs. One-shot deviation principle requires the knowledge of agents’ private strategies after deviations, and I characterize the necessary and sufficient condition for all IC constraints that requires only the knowledge of agents’ equilibrium strategies. I also provide two sufficient conditions for smaller set of IC constraints that require obedience after a single-period deviation to be sufficient for all IC constraints. I illustrate how to apply revelation principle and the smaller set of IC constraints with an application allowing for endogenous state.
    Keywords: dynamic mechanism design, adverse selection, moral hazard, revelation principle, one-shot deviation principle, endogenous state
    Date: 2017
  12. By: Tatsuyoshi Saijo (Research Center for Future Design, Kochi University of Technology); Junyi Shen (Research Institute for Economics and Business Administration, Kobe University)
    Abstract: Saijo, Okano, and Yamakawa (2015) showed that the mate choice mechanism for a symmetric prisoner's dilemma (PD) game implements cooperation in backward elimination of weakly dominated strategies (BEWDS), and it attained almost full cooperation in their experiment. This study theoretically shows, first, that this mechanism works well in the class of quasi-dilemma (QD) games, such as asymmetric PD games and coordination games. Second, the class of BEWDS-implementable games is exactly the same as the class of QD games. Third, the mechanism cannot implement cooperation in a subgame perfect equilibrium. Finally, we confirm that the mate choice mechanism works well experimentally for an asymmetric PD game.
    Keywords: Asymmetric prisoner's dilemma, Quasi-dilemma, Mate choice mechanism
    JEL: C72 C92 D74 P43
    Date: 2017–10
  13. By: Daniel Herold (Justus-Liebig-University Giessen)
    Abstract: This paper presents a moral hazard model analyzing the agent's incentive to commit corporate crime. The principal can only observe profits which the agent can increase by committing crime or exerting effort. It is shown how different incentive contracts, i.e., thresholdlinear, capped bonus and linear contracts, can be adjusted in order to promote agent's law abiding behavior. Any adjustment implies a loss in internal eciency which decreases in individual sanctions imposed on the agent.
    Keywords: moral hazard, incentive pay, corporate crime, cartels
    JEL: D82 D86 L14 L22 K20 K21
    Date: 2017
  14. By: Suehyun Kwon
    Abstract: This paper studies a selling mechanism where the seller first charges a fee for advice (information structure) then sells a product. When the buyer has no private information, the seller can extract full surplus, both when the seller has private information and when he doesn’t. If only the buyer has private information, the seller cannot extract full surplus. When both the seller and the buyer have private information, selling advice can strictly increase the probability of trade, and it is welfare-improving for both parties. In the private-value setting, Myerson-Satterthwaite no-trade theorem can be overcome by this mechanism. If the seller’s valuation doesn’t depend on the buyer type, then commitment power doesn’t change results, but with interdependent values, the limited-commitment solution cannot replicate the full-commitment solution.
    Keywords: information design, dynamic informed-principal problem, interdependent values, limited commitment, Myerson-Satterthwaite
    Date: 2017
  15. By: Karle, Heiko; Peitz, Martin; Reisinger, Markus
    Abstract: For many products, platforms enable sellers to transact with buyers. We show that the competitive conditions among sellers shape the market structure in platform industries. If product market competition is tough, sellers avoid competitors by joining different platforms. This allows platforms to sustain high fees and explains why, for example, in some online markets, several homogeneous platforms segment the market. Instead, if product market competition is soft, agglomeration on a single platform emerges, and platforms fi ght for the dominant position. These insights give rise to novel predictions. For instance, market concentration and fees are negatively correlated in platform industries, which inverts the standard logic of competition.
    Keywords: endogenous segmentation; intermediation; market structure; price competition; Two-sided markets
    JEL: D43 L13
    Date: 2017–11
  16. By: Wen, Xingang (Tilburg University, Center For Economic Research); Hagspiel, V. (Tilburg University, Center For Economic Research); Kort, Peter (Tilburg University, Center For Economic Research)
    Abstract: This paper studies how the subsidy support, e.g. price support and reimbursed investment cost support, affects the investment decision of a monopoly firm under uncertainty and analyzes the implications for social welfare. The analytical results show that the unconditional, i.e., subsidy support that is introduced from the beginning, makes the firm invest earlier. Under a linear demand structure, the unconditional subsidy cannot align the firm's investment decision to the social optimal one. However, a conditional subsidy, i.e., subsidy support introduced at the social optimal investment threshold, can align the two decisions. For a non-linear demand structure, it is possible for the unconditional subsidy to make the firm invest according to the social optimum. When the investment decisions are aligned, the firm's investment leads to the first-best outcome.
    Keywords: Investment under Uncertainty; Capacity Choice; welfare analysis; Linear Demand; Non-linear Demand
    JEL: D81 L51
    Date: 2017
  17. By: Herweg, Fabian (University of Bayreuth); Schwarz, Marco A. (University of Innsbruck)
    Abstract: Cost overrun is ubiquitous in public procurement. We argue that this can be the result of a constrained optimal award procedure: The procurer awards the contract via a price-only auction and cannot commit not to renegotiate. If cost differences are more pronounced for a fancy than a standard design, it is optimal to fix the standard design ex ante. If renegotiation takes place and the fancy design has higher production costs or the contractor\'s bargaining position is strong, the final price exceeds the initial price. Moreover, the procurer cannot benefit from using a multi-dimensional auction, i.e., under the optimal scoring auction each supplier proposes the standard design.
    Keywords: auction; cost overrun; procurement; renegotiation;
    JEL: D44 D82 H57
    Date: 2017–11–09
  18. By: Pablo Kurlat; Florian Scheuer
    Abstract: We study competitive equilibrium in a signaling economy with heterogeneously informed buyers. In terms of the classic Spence (1973) model of job market signaling, firms have access to direct but imperfect information about worker types, in addition to observing their education. Firms can be ranked according to the quality of their information, i.e. their expertise. In equilibrium, some high type workers forgo signaling and are hired by better informed firms, who make positive profits. Workers’ education decisions and firms’ use of their expertise are strategic complements, allowing for multiple equilibria. We characterize wage dispersion and the extent of signaling as a function of the distribution of expertise among firms. The market can create insufficient or excessive incentives for firms to acquire information, and we provide a formula to measure this inefficiency. Our model can also be applied to a variety of other signaling problems, including securitization, corporate financial structure, insurance markets, or dividend policy.
    Date: 2017
  19. By: Ariel Neufeld; Mario Sikic
    Abstract: We study robust stochastic optimization problems in the quasi-sure setting in discrete-time. The strategies are restricted to those taking values in a discrete set. The optimization problems under consideration are not concave. We provide conditions under which a maximizer exists. The class of problems covered by our robust optimization problem includes optimal stopping and semi-static trading under Knightian uncertainty. Moreover, it also can be considered as an approximation of general nonconcave robust stochastic optimization problems.
    Date: 2017–11
  20. By: Karpov, Aleksandr
    Abstract: The paper develops a model of price competition in presence of consumers with limited attention. Education and obfuscation marketing strategies are studied. It is shown that firms in highly competitive industries have incentives to obfuscate, but firms in low competitive industries have not.
    Keywords: bounded rationality,hotelling linear city model,consideration set,limited attention,unawareness
    JEL: D03 D11 D43
    Date: 2017
  21. By: Yuval Peres; Miklos Z. Racz; Allan Sly; Izabella Stuhl
    Abstract: It is well known that sequential decision making may lead to information cascades. That is, when agents make decisions based on their private information, as well as observing the actions of those before them, then it might be rational to ignore their private signal and imitate the action of previous individuals. If the individuals are choosing between a right and a wrong state, and the initial actions are wrong, then the whole cascade will be wrong. This issue is due to the fact that cascades can be based on very little information. We show that if agents occasionally disregard the actions of others and base their action only on their private information, then wrong cascades can be avoided. Moreover, we study the optimal asymptotic rate at which the error probability at time $t$ can go to zero. The optimal policy is for the player at time $t$ to follow their private information with probability $p_{t} = c/t$, leading to a learning rate of $c'/t$, where the constants $c$ and $c'$ are explicit.
    Date: 2017–11
  22. By: Philipp Renner; Simon Scheidegger
    Abstract: We propose a generic method for solving infinite-horizon, discrete-time dynamic incentive problems with hidden states. We first combine set-valued dynamic programming techniques with Bayesian Gaussian mixture models to determine irregularly shaped equilibrium value correspondences. Second, we generate training data from those pre-computed feasible sets to recursively solve the dynamic incentive problem by a massively parallelized Gaussian process machine learning algorithm. This combination enables us to analyze models of a complexity that was previously considered to be intractable. To demonstrate the broad applicability of our framework, we compute solutions for models of repeated agency with history dependence, many types, and varying preferences.
    Keywords: Dynamic Contracts, Principal-Agent Model, Dynamic Programming, Machine Learning, Gaussian Processes, High-performance Computing
    JEL: C61 C73 D82 D86 E61
    Date: 2017
  23. By: Motta, Massimo; Tarantino, Emanuele
    Abstract: It has been suggested that mergers, by increasing concentration, raise incentives to invest and hence are pro-competitive. To study the effects of mergers, we rewrite a game with simultaneous price and cost-reducing investment choices as one where firms only choose prices, and make use of aggregative game theory. We find no support for that claim: absent effciency gains, the merger lowers total investments and consumer surplus.Only if it entails suffcient effciency gains, will it be pro-competitive. We also show there exist classes of models for which the results obtained with cost-reducing investments are equivalent to those with quality-enhancing investments.
    JEL: K22 D43 L13 L41
    Date: 2017
  24. By: Jörg Franke; Wolfgang Leininger; Cédric Wasser
    Abstract: We analyze the revenue-enhancing potential of favoring specific contestants in complete information all-pay auctions and lottery contests with several heterogeneous contestants. Two instruments of favoritism are considered: Head starts that are added to the bids of specific contestants and multiplicative biases that give idiosyncratic weights to the bids. In the all-pay auction, head starts are more effective than biases while optimally combining both instruments even yields first-best revenue. In the lottery contest, head starts are less effective than biases and combining both instruments cannot further increase revenue. As all-pay auctions revenue-dominate lottery contests under optimal biases, we thus obtain an unambiguous revenue-ranking of all six combinations of contest formats and instruments.
    Keywords: all-pay auction, lottery contest, favoritism, head start, revenue dominance
    JEL: C72 D72
    Date: 2016

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