Showing papers in "The Bell Journal of Economics in 1979"

Moral Hazard and Observability

Abstract: The role of imperfect information in a principal-agent relationship subject to moral hazard is considered. A necessary and sufficient condition for imperfect information to improve on contracts based on the payoff alone is derived, and a characterization of the optimal use of such information is given.

Issues in assessing the contribution of research and development to productivity growth

Abstract: The article outlines the production function approach to the estimation of the returns to R&D and then proceeds to discuss in turn two very difficult problems: the measurement of output in R&D intensive industries and the definition and measurement of the stock of R&D 'capital'. Multicollinearity and simultaneity are taken up in the next section and another section is devoted to estimation and inference problems arising more specifically in the R&D context. Several recent studies of returns to R&D are then surveyed, and the paper concludes with suggestions for ways of expanding the current data base in this field.

Monopolistic competition with outside goods

Abstract: The Chamberlinian monopolistically competitive equilibrium has been explored and extended in a number of recent papers. These analyses have paid only cursory attention to the existence of an industry outside the Chamberlinian group. In this article I analyze a model of spatial competition in which a second commodity is explicitly treated. In this two-industry economy, a zero-profit equilibrium with symmetrically located firms may exhibit rather strange properties. First, demand curves are kinked, although firms make "Nash" conjectures. If equilibrium lies at the kink, the effects of parameter changes are perverse. In the short run, prices are rigid in the face of small cost changes. In the long run, increases in costs lower equilibrium prices. Increases in market size raise prices. The welfare properties are also perverse at a kinked equilibrium.

Imperfect Information, Dividend Policy, and "The Bird in the Hand" Fallacy

Abstract: This paper assumes that outside investors have imperfect information about firms' profitability and that cash dividends are taxed at a higher rate than capital gains. It is shown that under these conditions, such dividends function as a signal of expected cash flows. By structuring the model so that finite-lived investors turn over continuing projects to succeeding generations of investors, we derive a comparative static result that relates the equilibrium level of dividend payout to the length of investors' planning horizons.

Individual Discount Rates and the Purchase and Utilization of Energy-Using Durables

Abstract: This article presents a model of individual behavior in the purchase and utilization of energy-using durables. The tradeoff between capital costs for more energy efficient appliances and operating costs for the appliances is emphasized. Using data on both the purchase and utilization of room air conditioners, the model is applied to a sample of households. The utilization equation indicates a relatively low price elasticity. The purchase equation, based on a discrete choice model, demonstrates that individuals do trade off capital costs and expected operating costs. The results also show that individuals use a discount rate of about 20 percent in making the tradeoff decision and that the discount rate varies inversely with income.

Risk Sharing and Incentives in the Principal and Agent Relationship

Abstract: This article studies arrangements concerning the payment of a fee by a principal to his agent For such an arrangement, or fee schedule, to be Pareto optimal, it must implicitly serve to allocate the risk attaching to the outcome of the agent's activity in a satisfactory way and to create appropriate incentives for the agent in his activity Pareto-optimal fee schedules are described in two cases: when the principal has knowledge only of the outcome of the agent's activity and when he has as well (possibly imperfect) information about the agent's activity In each case, characteristics of Pareto-optimal fee schedules are related to the attitudes toward risk of the principal and of the agent

A model of duopoly suggesting a theory of entry barriers

Abstract: This paper analyzes a model of duopoly with fixed costs. Leadership by one "established" firm may yield an outcome in which the second is inactive, but entry prevention is not a prior constraint. We find that two aspects of product differentiation have distinct effects: an absolute advantage in demand for the established firm makes entry harder, but a lower cross-price effect facilitates it. In the basic model we maintain the same quantity after entry. An extension of the model deals with the case where the threat of a predatory output increase after entry is made credible by carrying excess capacity prior to entry.

Investment Strategy and Growth in a New Market

Abstract: This paper studies the strategic interaction among firms in a growing market. It focuses upon the investment decisions of the firms. Central to the analysis is the idea that investment and growth for the firm are constrained by physical and financial factors. Firms that enter early and/or firms that can grow rapidly can make preemptive investments. The paper studies the optimal levels of preemptive investment and the implications for the long-run structure of the market. The analysis of optimal preemption is similar in spirit to the von Stackelberg equilibrium concept in oligopoly theory.

An Equilibrium Analysis of Search and Breach of Contracts, I: Steady States

Abstract: We study the steady-state equilibrium of models where individuals meet pairwise in a costly stochastic search process and negotiate contracts to product output. Different meetings yield different outputs, and so an individual in a contract may wish to continue search to find a better match. If he is successful, he will break his original contract. In anticipation of possible breaches, contracts may provide for compensation to be paid to the breached-against partner. We examine the effects that several alternative damage rules have on equilibrium search and breach behavior.

A regulatory adjustment process for optimal pricing by multiproduct monopoly firms

Abstract: This paper describes an incentive mechanism that is shown to enforce the use of Ramsey prices by multiproduct monopolies. The constraint given is simple. It limits information requirements on the regulatory agency to bookkeeping data of the firm. Its implementation could be easily controlled by outside courts or auditors. The process, therefore, makes use of invisible hand properties shifting the workload of welfare optimization from the regulatory agency to the regulated firm.

The Impact of Occupational Safety and Health Regulation

Abstract: Occupational health and safety regulation imposes on enterprises an expected penalty that is positively related to the presence of unsafe working conditions for firms not in compliance with the standards. Higher expected penalties will increase enterprises' investment in work quality inputs, which in turn will lead workers to reduce their safety-enhancing actions. Low and moderate expected penalty levels increase health and safety, whereas very severe penalties may have a counterproductive effect. Present OSHA penalty levels are too low to create an effective financial incentive. The analysis of pooled time series and cross section data on industry health and safety investments and injury rates for the 1972-1975 period failed to indicate any significant OSHA impact for the data set analyzed.

Investment Income and Profit Margins in Property-Liability Insurance: Theory and Empirical Results

Abstract: The present analysis applies the capital-asset pricing model (CAPM) of contemporary financial theory to derive risk-adjusted rates of return that the capital markets require of stock property-liability insurers The required profit margins in insurance premiums for the major property-liability lines that are consistent with these rates of return are derived using estimated multiquarter cash flows for premiums and costs These margins have been used by the Massachusetts Commissioner of Insurance in rate decisions or rate reviews for all the major property-liability lines and for medical malpractice insurance They represent an effort to bring the consideration of insurer profits within a framework of modern financial theory A distinctive feature of the margins developed here is that, because they do not depend upon actual investment results for insurers’ portfolios, they offer a nonintrusive regulatory solution of the long controversy over the use of investment income in insurance rate setting1

Consumer Information, Equilibrium Industry Price, and the Number of Sellers

Abstract: Define a reputation good to be any product or service for which sellers' products are differentiated and consumers' search among sellers consists of a series of inquiries to relatives, friends, and associates for recommendations. Examples of reputation goods are personal legal services and primary medical care. The paper shows that if a monopolistically competitive industry sells a reputation good, then an increased number of sellers may perversely cause the industry's equilibrium price to rise. This result is based on maximizing behavior on both sides of the market: consumers are assumed to search rationally and sellers are assumed to profit maximize.

Profit regulation in property- liability insurance

Abstract: There has been substantial interest in the question of how (and whether) to allow for investment income in setting rates for property-liability insurers. In a sense this interest is premature, since the fair (i.e., competitive) total profit for an insurance firm has not been defined except by unsupported rules of thumb. This article uses the capital asset pricing model to determine the competitive insurance premium and profit rate. Fair profit rates for real lines of insurance are then calculated and compared with actual profit rates. The comparison suggests that rule-of-thumb profit rates used in regulation are above the level that would occur in a competitive insurance market.

A note on the relative efficiency of property-liability insurance distribution systems

Abstract: Property-liability insurance is distributed through two major marketing channels—the independent and the exclusive agency systems. Independent agents place business with several companies, while exclusive agents write insurance for only one company. We find that the independent agency system is less efficient than the exclusive agency system. The efficiency differential did not change significantly during the period 1968 through 1976. When we used the total rather than the underwriting costs to measure expenses, we found that the relative but not the absolute expense differential was reduced. This suggests that the inefficiencies of the independent agency companies stem from marketing and administrative rather than loss adjustment procedures. The findings imply that regulators should play a more active role in the dissemination of information on property-liability insurance prices.

Advertising, Concentration, and Profitability: The Simultaneity Problem

Abstract: This article examines the identification of a system of equations which seeks to explain industrial profitability, concentration, and advertising intensity. We specify a concentration equation which reflects a dynamic adjustment to a long-run level which depends on the nature of entry conditions. The specification of the concentration equation is seen to be critical to the identification of the profitability equation. We test the model against a sample of input-output table detailed industries and find that the resulting estimates suggest the importance of avoiding the omission of relevant explanatory variables.

Economic criteria for optimizing power system reliability levels

Abstract: A generalized simulation model for optimizing the reliability level of electrical supply is described. The model is applied to a case study of Cascavel, Brazil to determine a range of optimum reliability levels for long range electric power distribution system planning. The basis of the model is its comparison of the social benefits and costs of changes in power system reliability. The supply side costs of increasing system reliability can be determined from straight forward engineering considerations. On the demand side, the benefits of electricity users consist of cost savings from averted power failures or outages, which may be measured by the disruption of the output streams owing to idle input factors and spoilage. The results of the Cascavel case study indicate that the principal outage costs are incurred by industrial and residential consumers. This fact is reflected in the optimum design of the distribution system, with the high population density core city area and the industrial zone receiving the most reliable service. 22 references.

A cross sectional study of freight transport demand and rail-truck competition in canada

Abstract: This article derives a rail-track freight demand model that is consistent with the economic theory of modal choice in the price-speed-reliability space. The translog model is estimated from the cross sectional data of Canadian interregional freight flows for the eight selected commodities. Major empirical findings are: (i) The quality attributes of service significantly influence modal choice only for the relatively high-value commodities. (ii) Both the price and quality elasticities of demand and the elasticity of rail-truck substitution vary substantially from route to route as well as from commodity to commodity. This implies that CES models including Cobb-Douglas form should not be used for freight demand studies. (iii) For the relatively high-value commodities, short-haul traffic is largely dominated by the truck mode, and significant rail-truck competition exists only in the medium and long-haul markets. (iv) For the relatively low-value commodities, effective rail-truck competition exists only in the short-haul markets. Hence, the medium and long-haul markets are largely rail-dominated.

The Demand for Dental Care

Abstract: Inclusion of dental coverage in a number of National Health Insurance bills has raised questions about the determinants of demand for dental services, particularly, the sensitivity of demand to out-of-pocket cost. This paper relies on a 1970 national cross sectional survey of individuals to estimate demand for dental services. With full coverage (no out-of-pocket cost), the predicted number of visits is over twice as high for adults and over three times as high for children as are their demands with no dental insurance coverage. Full or partial coverage will increase considerably the demand for dental care, even if coverage is limited to children and if copayments and deductibles are imposed. With supply unaltered, the short-term effects of this excess demand will include some combination of price increases, increased queues, changes in the nature of the dental services performed, or other forms of nonprice rationing.

Liability rules, limited information, and the role of precedent

Abstract: Recent studies of the role of law in distributing accident costs have led to the pessimistic conclusion that because judges lack the information to discover the efficient level of care, efficiency cannot be achieved by common law tort rules. We show that judges have enough information to revise the legal standard via the mechanism of precedent so that the standard adopted tends toward efficiency. This optimistic conclusion results from changing previous models so that the level of care taken by litigants affects the information available to the court, but does not directly influence the legal standard. We model a sequence of court decisions by differential equations and show that the unique, stable equilibrium is efficient.

Adverse Selection, Dissembling, and Competitive Equilibrium

Abstract: Rothschild and Stiglitz have shown than insurance markets and other markets in which an adverse-selection problem exists cannot have Nash-type pooling or subsidized separating equilibria and are unlikely to have Nash-type unsubsidized separating equilibria. Wilson, Miyazaki, and Riley have analyzed anticipatory pooling and subsidized-separating equilibria and reactive unsubsidized separating equilibria. Each of these alternatives to Nash-type equilibria requires strategic behavior on the part of insurance sellers for support. The present paper analyzes as another alternative pooling equilibria that require dissembling behavior on the part of insurance buyers for support. This dissembling model has the attractive feature that it takes explicit account of the convention of requiring insurance buyers to submit applications, a practice that the analysis interprets to be a natural response to the adverse-selection problem.

Advertising, Consumer Information, and Product Quality

Abstract: This article analyzes a monopolist's quality and advertising policies and evaluates their social optimality. Our model considers a rational, though not fully informed, consumer who holds prior perceptions about aspects of quality, which determine his purchase pattern. These quality perceptions constitute the product's goodwill. Differences between expected and experienced quality lead to reevaluation of expectations. Monopolists affect these perceptions, and hence build up goodwill, by advertising and quality attribute variations. These affect consumer welfare directly and indirectly by their informational content. We find that advertising may profitably mislead, at least in the short run. Although the welfare effects of a monopolist's quality and advertising policies are not generally determinate, even when information is untrue, we are able to evaluate the welfare determinants of advertising policy from an objective standard and to specify some of the conditions under which advertising is socially excessive.

Preempting an Alert Rival: Strategic Timing of the First Plant by Analysis of Sophisticated Rivalry

Abstract: This paper examines the strategic rivalry in a duopoly where firms must correctly time the construction of the first plant in a growing market. We explicitly model rivalry for market share. Firms recognize the effect of the rival's actions on their profits; they behave noncooperatively to maximize discounted profits over the infinite horizon. For the timing problem we develop an appropriate solution concept. It is a Nash equilibrium in the space of sequential decision rules which specify each firm's correct action as a function of the state of the world. We then show how the equilibrium can be computed by backward induction dynamic programming. Numerical examples illustrate the sequential Nash solution and characterize the rivalry to be the first to build. Parametric analysis of the example enables us to explore the competitive dynamics of capacity choice in new markets.

Corporate Control and Managerial Misrepresentation of Firm Performance

Abstract: This paper presents two tests of the hypothesis that the managers of management-controlled firms exercise their control over the information contained in annual reports in a manner which may misrepresent firm performance. The first test finds that management-controlled firms have a significantly smaller proportion of years in which the signs of unexpected accounting earnings and unexpected security returns are the same than do owner-controlled firms. The second test finds that the timing of certain accounting policy decisions made by the managers of management-controlled firms is related to the current level of the firm's security return performance.

Technology, Regulation, and Market Structure in the Modern Pharmaceutical Industry

Abstract: This paper describes the transformation of the American pharmaceutical industry into its modern configuration in the 1950s. The industry was faced with new regulatory and technological conditions which changed both the way drugs were marketed and what drugs were marketed. The new conditions led to substantially larger drug firms and increased vertical integration, but not to increased concentration or relative profitability in the drug industry. The reasons for this pattern of development stem from the interaction among the FDA's regulations on drug marketing, the limits of patent protection, and the nature of the new technology.

The economics of timber: a renewable resource in the long run

Abstract: Critics of current and historical trends in timber production contend that private owners cut their woods more quickly than optimal, while public managers cut their forests more slowly than optimal. Using the Douglas fir industry, this chapter shows that private entrepreneurs holding rational expectations with respect to future prices have historically been discounting the future at a real rate of 5 percent, a much lower rate than that available for other private investments, and, therefore, that these owners have not cut their forests prematurely. It describes the time period of the model, the relation of profits to supply at expected prices, and the formation of price expectations. The chapter discusses the estimation of the demand equations and describes the producer's profit functions which are built from a linear model of biological growth of Douglas fir. It presents the estimation of the supply equation and the test of the hypothesis that private owners cut their timber prematurely.

Warning on the use of linear logit models in transport mode choice studies

Abstract: It is argued that linear logit models are inappropriate to use for transport demand studies because they impose many rigid a priori restrictions on the parameters of price responsiveness of demand, such as the elasticities of substitution and cross price elasticities, and the structure of technology (or preference) underlying the linear logit models has severe irregularity and inconsistency. This has a serious implication for the credibility of the findings of several recent studies which attempted to measure the welfare loss of traffic misallocation attributable to the Interstate Commerce Commission's railroad minimum rate regulation.

Divide and Conquer: Microfoundations of a Marxian Theory of Wage Discrimination

Abstract: Microfoundations for a divide-and-conquer model of wage discrimination are provided by positing that workers' psychologies permit racial integration of firms to weaken workers' unity and hence reduce their bargaining power against employers. In this bargaining -- as opposed to competitive -- model of wage determination, there are discriminatory equilibria at which both white and black workers are worse off and employers are better off than would be the case without worker dissension. Furthermore, owing to the bargaining structure, market forces cannot unravel the discriminatory wage bargain.

Behavior of a monopoly offering interruptible service

Abstract: A monopoly offering service to its customers on an interruptible basis has the option of curtailing delivery of this service when available supply falls short of demand. Shortages occur because of the stochastic nature of demand. To do this the monopolist divides the customers into classes based on some observable characteristics, and then determines the order in which service to these classes is interrupted. The order is a decision variable that influences profits and is relevant only in the stochastic framework. In addition, the monopolist discriminates among the classes on the basis of price and reliability of service. These decision variables, in turn, influence demands. An optimum policy for any ordering is one where prices, capacity, and quoted reliabilities of service maximize expected profit, and at the same time are compatible with the actual reliabilities of service. We derive some conditions for which an ordering yields the greatest profit.

Conditional Logit Analysis of FCC Decisionmaking

Abstract: The FCC's 1965 policy statement concerning decisions in comparative broadcast licensing cases was a response to criticisms that the process was arbitrary and unrelated to the applicants' comparative merits. Subsequent decisions presumably based on the stated criteria have continued to be attacked. Most of the criticisms, however, are founded on anecdotal analyses rather than on systematic statistical results. Conditional logit analysis of the FCC's revealed preferences indicates that the FCC has done better than the critics have realized. Those criteria which are stated to be most important are indeed those which are statistically significant in the decision functions: specifically, the integration of ownership with management and the diversification of mass media ownership. Furthermore, there is little difference between the decision functions of initial and review level decisionmakers.