Showing papers in "The Bell Journal of Economics and Management Science in 1973"

Cartels, competition and regulation in the property-liability insurance industry

Abstract: This paper provides a detailed study of the structure, behavior, and performance of the property and liability insurance industry in the United States. The property insurance industry is shown to possess all of the structural characteristics normally associated with competitive markets. Despite a competitive market structure, however, the property-liability insurance industry has traditionally set prices through cartel-like rating bureaus and has been subjected to pervasive state rate regulation. The study concludes that the combination of state regulation, cartel pricing, and other legal peculiarities has resulted in the use of an inefficient sales technique, supply shortages, and overcapitalization. Free entry, however, tends to drive profits toward the cost of capital. Based on recent experience in states where the competitive market is used to determine insurance rates, the study suggests a movement away from rate regulation and cartel pricing to open competition, as a means of eliminating prevailing performance problems.

Proof That Properly Discounted Present Values of Assets Vibrate Randomly

Abstract: Even the best investors seem to find it hard to do better than the comprehensive common-stock averages, or better on the average than random selection among stocks of comparable variability. Examination of historical samples of percentage changes in a stock's price show that, when these relative price changes are properly adjusted for expected dividends paid out, they are more or less indistinguishable from white noise, or, at the least, their expected percentage movements constitute a driftless random walk (or random walk with mean drift specifiable in terms of an interest factor appropriate to the stock's variability or riskiness). The present contribution shows that such observable patterns can be deduced rigorously from a model which hypothesizes that a stock's present price is set at the expected discounted value of its future dividends, where the future dividends are supposed to be random variables generated according to any general (but known) stochastic process. This fundamental theorem follows by an easy superposition applied to the 1965 Samuelson theorem that properly anticipated futures prices fluctuate randomly -- i.e., constitute a martingale sequence, or a generalized martingale with specifiable mean drift. Examples demonstrate that even when the economy is not free to wander randomly, intelligent speculation is able to whiten the spectrum of observed stock-price changes. A subset of investors might have better information or modes of analysis and get above average gains in the random-walk model; and the model's underlying probabilities could be shaped by fundamentalists' economic forces.

Predicting railroad bankruptcies in america

Abstract: Author discusses the urgent need for an early-warning system covering the historically failure-prone railroad industry and to develop a tool for providing such a system. A multivariate statistical technique called linear discriminant analysis is utilized to identify and quantify those financial measures which are effective indicators of bankruptcies. A model which combined several financial statement ratios proved to be extremely accurate in predicting railroad bankruptcies at one and two annual financial statement dates prior to failure. Subsequent tests on additional railroad samples confirm the validity of the model. Currently existing railroads in America are assessed for their bankruptcy potential by this diagnostic model.

Consumption externalities and imperfect corrective pricing

Abstract: Pricing congested facilities above marginal production cost is a conventional approach to improving resource allocation. Where everyone is producing the same externality, a uniform price (in excess of marginal cost by the value of the externality) permits the competitive equilibrium to be Pareto optimal. Where individuals give rise to different externalities, but a uniform price is in effect, we have a second-best situation. When demands depend only on price, price should exceed marginal cost by a weighted average of externalities generated, the weights being the price derivatives of demand. When demands also depend on congestion, the optimal price generally diverges from this rule. The price should be lower when the individuals giving large external diseconomies per unit demanded tend to be price insensitive and congestion sensitive in their demands (relative to the average). In this case public expenditures to decrease congestion directly should not be carried to the point where the marginal direct benefit from congestion reduction equals the marginal cost. Optimal income distribution is also examined.

The optimum factory town

Abstract: This paper studies the determination of the optimum size and arrangement of a monocentric city. The major consideration is the trade-off' between economies of scale in production in the central business district and the diseconomies of congestion in commuter transport. Planned optimum allocations and their decentralized implementation by suitable taxes and transfers are discussed. Rent and density profiles and land use are solved in closedform, and complete numerical solutions are obtained for particular parameter values. It is shown that negative exponential rent and density profiles may not be very good approximations, and that cities of more than a million inhabitants are dificult to justify in the,framework considered. * The general conceptual framework of the theory of monocentric cities is too well-known to need another airing.' In this paper I offer improvement on earlier work at several specific points. I shall indicate these by comparing this paper with some recent ones. The most serious defect common to several of these papers (e.g. those of Solow and of Oron, Pines, and Sheshinski2) is their assumption of nonincreasing returns to scale in production in the central business district. This destroys all rationale for organizing production in a city, as dispersed production will save transport costs without losing output. To preserve the urban structure, we must then impose the condition that all output has to be shipped to a point market place, which is an arbitrary and unsatisfactory way out. The role of increasing returns in understanding urban problems is clearly stated by Koopmans,3 and general theorems relating city size to increasing returns are proved by Mirrlees and Starrett.4 I shall be concerned with more specific cases which can yield approximate numerical results,

The Economics of Product Safety

Abstract: The report of the National Commission on Product Safety stated that the American public is being exposed to many unreasonably hazardous products. Further, the post-accident remedies to compensate victims of product-related accidents are inadequate and encourage the continued production of unsafe products. It is believed that a shift in assignment of liability for accident costs from consumers to sellers would discourage sales of the more hazardous product grades thereby reducing the frequency and severity of home accidents. This conclusion cannot be derived from economic theory. Indeed, under fairly plausible conditions, a shift to producer liability can lead to the increased production of riskier product grades. The theory developed in this paper argues that the demand for a risky product is determined by the full price consisting of the price of the parent risky good plus the imputed expected damage costs. The consumer maximizes utility by demanding that product grade which minimizes his full price. In the concluding section of the paper, attention is directed to the welfare implications of the policy alternatives for the product safety problem.

Congestion cost and use of land for streets

Abstract: The traditional model of the equilibrium economic geography of a monocentric city is generalized to introduce congestion costs as well as distance costs of the transportation This has the effect of generating more curvature in the equilibrium rent gradient than the early theory had suggested More important, if congestion tolls are not charged on crowded roads, land rents will reflect the private costs of transportation, not the full social cost Market land values will then be faulty guides to land use, and cost-benefit analyses will give misleading results Some sample computations suggest that the result will often be to cause more land to be taken for use as streets than is socially desirable, especially nearer the center of the city

The telephone system as a public good: static and dynamic aspects

Abstract: The paper uses standard concepts of equilibrium and efficiency to analyze certain properties of the telephone system. The property of accesslno access plays a central role in the analysis, and it is suggested that many so-called "systems" in modern life have similar access/no access properties. The fundamental discreteness associated with access/no access is handled first in a static resource allocation framework. Also, the concept of transaction cost is brought into the analysis in relation to time budgets. It is shown that the conventional efficiency conditions of the theory of public goods do not hold. Alternative results are given and interpreted. A dynamic analysis of the demand for telephone service is then developed. Using a set of very weak assumptions, we prove, by induction, the existence of a self-sustaining growth process in demand. The underlying assumptions are weak in the sense that they imply stationary conditions: a constant population, with constant incomes, a stationary income distribution, and no change in relative prices. The growth process which nevertheless arises can be explained jointly by the distribution of income and by the public-goodproperty inherent in the telephone system.

A Decision Analysis with Multiple Objectives: The Mexico City Airport

Abstract: This paper reports an analysis done for the Secretaria de Obras Publicas (Ministry of Public Works) of Mexico to help select the most "effective" strategy for developing the airport facilities of the Mexico City metropolitan area to insure quality air service for the remainder of the century. Effectiveness is a complex function including attributes of cost, safety, capacity of the airport facilities, noise levels, social disruption, and access times. A decision analytic model was used for evaluating strategies. The attributes were adapted to account for impacts over time, and probability density functions and a utility function were assessed over the six attributes. Details of these assessments are given. The results and implications of the analyses are discussed. A unique aspect of the study involved the assessment of a multiattribute utility function and its use to aid an important policy decision.

The Profit-Performance Effects of the Separation of Ownership from Control in Large U. S. Industrial Corporations

Abstract: After a survey of the empirical studies of Monsen, Chiu, and Cooley, of Kamerschen, and of Larner on the effects of the separation of ownership from control, this paper presents a study which shows that among firms with a high degree of monopoly power, management-controlled firms report significantly lower profit rates than owner-controlled firms. The works of Bain, Mann, and Shepherd and a 1967 FTC study supply information on barriers to entry, which more aptly capture the effect of separation of ownership and control. The findings confirm Hall and Weiss' conclusion that there is less variation in profit rates among large firms than among small ones.

Alternative regulatory policies for dealing with the natural gas shortage

Abstract: Low wellhead ceiling prices over the past decade have led to the beginning of a shortage in natural gas production. If the demand for gas grows as expected during the 1970s, and if ceiling prices remain low as a result of restrictive regulatory policy, this shortage could grow significantly. This paper examines the effects of this and alternative regulatory policies on gas reserves, production supply, production demand, and prices over the remainder of this decade. An econometric model is developed to explain the gas discovery process, reserve accumulation, production out of reserves, pipeline price markup and wholesale demand for production on a disaggregated basis. By simulating this model under alternative policy assumptions, we find that the gas shortage can be ameliorated (and after four or five years, eliminated) through phased deregulation of wellhead sales, along the lines proposed in President Nixon's April 1973 Energy Message. But the shortage is not reduced by changes in regulatory rulings on prices, even when the rulings allow price increases that are the maximum likely to be acceptable to the Courts. These results are rather insensitive to alternative forecasts of such exogenous variables as GNP growth, population growth, and changes in the prices of alternate fuels.

Some aspects of optimal pricing for telecommunications

Abstract: The published work on telecommunications has been primarily concerned with marginal-cost pricing and the peak-load problem: externalities generated by the telephone have been ignored. This article reverses the situation by stressing two externalities -- the one created when someone makes a call and the other created when a new subscriber joins the system. The first externality represents the benefit of an incoming call to the recipient of that call, a benefit for which he does not pay. The second arises from the fact that existing subscribers do not pay for the installation of the new subscriber's phone, but do obtain a benefit because they can now call the new subscriber if they so wish. Optimal prices are obtained allowing for these externalities and a measure is developed for the total benefits of the system.

Pricing decisions of regulated firms: a behavioral approach

Abstract: Once the prices for utility service are set by state regulatory authorities, they remain at fixed levels until they are officially increased or decreased by the regulatory agency. A utility company is not free to vary the prices of its service independently. This paper presents the results of an attempt to specify and estimate a behavioral model of the pricing decisions of regulated firms. The "threshold" behavior of regulated firms with regard to their decisions to seek general price increases from state regulatory authorities and their decisions to file "voluntary" price decreases is discussed, and two decision equations are specified and then estimated for regulated electric utilities in New York State. The decision to file for a price increase is shown to depend on the growth rate of earnings per share achieved by the firm in the current and previous year, on the level of interest coverage realized in the current year, and on a variable which measures prior expectations of success in the hearing room. The decision to file a voluntary price decrease is shown to depend on the growth rate in earnings per share and a variable which measures the expectations of "forced" regulation.

The Behavior of a Firm Subject to Stochastic Regulatory Review

Abstract: In recent years, the behavior of regulated public utilities has received increasing attention from economic theorists. The principal structure used in analyzing this behavior has been the Averch-Johnson model of the regulated firm. The current paper presents an alternative view of the regulated firm, one which attempts to narrow some (though by no means all) of the gaps between the now standard model and the actual regulatory process. In particular, the new model proposed here considers the firm's operations in a dynamic context -- with the firm looking to the future in making today's decisions -- and it incorporates the interplay between the regulatory agency and the firm. The model captures the price-setting role of the regulators, and it encompasses the phenomenon of regulatory lag. The uncertainty associated with the occurrence of rate reviews is modeled by positing that reviews occur stochastically through time. And, although the treatment of the issue is rather simplistic, the model does incorporate technical change generated by the regulated firm's program of research and development. The regulated firm's optimal policy is characterized, and the implications this optimal policy has for two traditional issues in regulatory economics -- the input efficiency of regulated firms and the effect of regulatory lag on research and development -- are examined.

Market Structure, Quality and Durability

Abstract: This paper analyzes the effects of market structure -- monopoly versus competition -- on the quality and durability of goods. Also, it tries to find the impact of government regulation on these variables. The types of quality improvements discussed are: quality as pure substitute for quantity; quality which increases the demand for the good; and quality improvement which increases the durability of the good. In general, it is impossible to deduce that quality is independent of market structure. It depends on the cost structure. The paper shows that when quality is a substitute for quantity, both quality and quantity of the monopoly might fall short of those in the competitive market. Regulating only quality, or only quantity, may increase the monopoly misallocations of resources. In other types of quality improvements discussed, it may turn out that quality and durability may be better or worse in the monopolized industry than in the competitive one. Regulating only quality may improve the resource allocation but not eliminate the bias. Quantity regulation by itself may be sufficient for producing the optimal flow of services.

Optimum vs. Equilibrium Land Use Pattern and Congestion Toll

Abstract: This paper presents a comparison between optimum and competitive land use patterns within an urban area. The concept of equilibrium in this paper pertains to five sectors: households, housing producers, composite commodity producers, land transactors and transportation authority. The concept of optimum referred to in this paper is the maximum utility level which can be realized provided that equals are treated equally. This optimum allocation can be supported by a competitive price system if a warranted congestion toll is collected by the transportation authority and redistributed as a lump sum subsidy. If less than the warranted congestion toll is collected, the resulting competitive allocation is distorted and then the competitive city tends to be more suburbanized than the optimum city.

Notes on the new urban economics

Abstract: Since about 1970, ten or twenty papers have been written making use of control theory or programming to analyze optimum or market equilibrium urban land use. The purpose of these notes is to survey and evaluate this new approach to urban economics. Most contributions to the new urban economics assume that employment is concentrated at the urban center, but that housing production functions permit the amount of housing per unit of land to vary with economic conditions. An optimum or equilibrium pattern of housing density is deduced as a function of distance from the center. All contributions include assumptions about the urban transportation system, and some have congestions built into the model. The last part of the paper is a discussion of discrete and continuous representation of urban space. The two possibilities lead to different mathematical representations, and we suggest that discrete representations may be more useful for many purposes.

An Econometric Planning Model for American Telephone and Telegraph Company

Abstract: In this paper an econometric model for corporate planning analysis is discussed and its operation is demonstrated by examples. The thrust of this effort has not been towards developing a new body of theory or detailed econometric examination of standard relationships in the theory. The main thrust has been towards the development of a capability for analyzing firm behavior utilizing economics in a straightforward fashion. The structure and econometrics simply allow the theory to be examined quantitatively. In a sense, this has been the theme of this development; that is, for present day corporate planning modeling, the state of applied economics and the availability of planning technology is such that comprehensive and informative models can be constructed on simple economic theory.

A Dynamic Model of the Regulated Firm with a Price Adjustment Mechanism

Abstract: Instead of the Averch-Johnson assumptions of instantaneous regulation of the rate of return, but no regulation over the setting of individual rates, this note assumes that the regulator applies the new rates to the test year's output to predict the revenue requirements under the allowed rate of return. A mathematical model of the firm is then worked out. When the A-J view of the regulated firm is dynamized in a rather straightforward fashion, the A-J point no longer has any special significance: it is not the stationary points of the dynamic version of the model. While it is true that the stationary-point does exhibit overcapitalization in the A-J sense, the regulatory agency can use the extent to which it adjusts prices as a further control variable to influence the stationary point.

The comparative statics properties of the theory of the regulated firm

Abstract: This paper presents an analysis of the comparative statics properties of the theory of the regulated firm. It is assumed that the firm either maximizes profit, subject to regulatory constraint, or maximizes revenue, subject to regulatory constraint and a profit constraint. The question asked in each case is whether there are comparative statics properties which distinguish effective from ineffective regulation. Several properties which do so are identified. In particular, the firm's derived demands are found to have some very striking properties. It is shown that if the regulatory constraint is effective, then at given output the firm's demand for capital decreases while its demand for labor increases with increases in the wage rate. These peculiar properties also occur in some cases when the regulatory constraint is not binding if revenue is maximized. However, there prove to be properties which conclusively distinguish revenue maximization from profit maximization.

Additive nonhomogeneous production functions in telecommunications

Abstract: An additive form of a nonhomogeneous production function is suggested in this paper as a tool to study economic trends in production processes. This information allows for variable elasticities of substitution and for variable economies of scale, and is readily estimated by ordinary least squares. The marginal products are explicitly stated as a function of the input ratios. This additive nonhomogeneous functional form has been empirically tested on telecommunications data, related to Bell System, Western Electric, and Bell Canada production systems. Marginal products and elasticities have been computed and compared with the same series generated by a multiplicative nonhomogeneous form recently proposed by H.D. Vinod. Several similarities as well as major differences between the findings are cited and discussed. The author concludes that the additive formulation offers a more plausible description of some aspects of the Bell System and Bell Canada production processes than comparable findings generated by the multiplicative formulation.

Pricing of Pollution: The Coase Theorem in the Long Run

Abstract: In an earlier article in The Bell Journal, Tybout argues that even in a zero transaction costs model, bribery to reduce pollution and compensation charges for it result in different total profits, and thus in different long-run behavior. Therefore, the Coase Theorem is refuted for the long-run case.

Resource Allocation and the Regulated Firm: Comment

Abstract: This comment presents an analysis of the effect of regulation on the sales-maximizing firm, and shows that the models used in earlier works have been incorrectly specified. It is demonstrated that under relatively weak conditions, regulation via a "fair" rate of return constraint has no influence on the behavior of the firm, and that any tendency to under-or overcapitalization would be present even if there were no regulation.

Relative Prices on Regulated Transactions of the Natural Gas Pipelines

Abstract: As in many regulated industries, jurisdiction of the commission regulating the natural gas pipelines does not encompass all transactions of the regulated companies. The Federal Power Commission does not regulate direct sales of the pipelines to industry, while it does set profit limits on sales to retail gas utilities companies. If regulation is effective, the prices on the regulated sales should be different from those on the unregulated industrial transactions, all else being equal. A model is constructed here of the behavior of the firm with split regulated-unregulated sales. Thenceforth, the model is tested against a sample of paired transactions. Thenceforth, the model is tested against a sample of paired transactions in the late 1960s. The findings are that price levels on regulated sales would not appear to have been different from those on unregulated sales, after account has been taken of cost and demand differences. The effects of regulation, while in the expected direction, were insubstantial. Moreover, the differences in the institution of price setting under regulation -- in particular, the widespread use of two-part tariffs -- if anything, enhanced the ability of the pipelines to charge identical regulated and unregulated prices.

Market Changes in the Computer Services Industry

Abstract: Competition is not a natural state. Under it, firms become dissatisfied with performance and work to change the structure. What they seek is a structure that supports sufficient discipline to assure individual actions consistent with common interests. Often, the changes have been effected before the industry is prominent enough to command public attention. This is not so in computer services. The industry, already prominent, is still competitive. In this paper, the author describes the industry and suggests why and how changes in its structure may occur.

Depreciation in a Simple Regulatory Model

Abstract: This study introduces depreciation as an explicit variable in a regulatory model. The goal of the firm is assumed to be maximization of discounted cash flow. For simplicity it is assumed that the firm is required to use the same type of depreciation for book and tax purposes. It is shown that under the assumptions of the model, rate-base regulation strongly affects the type of depreciation which the firm would consider optimal. More specifically, the solution of the model indicates that in order to maximize the discounted cash flow while satisfying the regulatory control, the firm should allocate depreciation in each period so that it will be an increasing function of time. As a result, undiscounted cash flow will increase through the time horizon.

Resource Allocation and the Regulated Firm: Comment on the Comments

Abstract: The revenue-maximizing firm presumably has an internal return requirement that is at least as large as the maximum return permitted by a regulatory agency. In this case, which is the only one that seems economically meaningful, the undercapitalization result of Bailey-Malone holds throughout the elastic region of the revenue curve.

Pricing of Pollution: Reply

Abstract: The conditions of internalization to which this note refers were derived by a general equilibrium analysis independent of site rentals, and would not be changed by properly including site rentals.

Investment Behavior in the U. S. Telephone Industry-1949 to 1968

Abstract: This paper applies the econometric model of investment behavior developed in our earlier paper to the U.S. telephone industry. Utilizing annual data for the period 1949 to 1968, the author finds that the estimates of long-run elasticities of capital stock with respect to relative price and output are 0.51119 and 1.18225, respectively. However, the Cobb-Douglas specification of Jorgenson and Handel appears to be valid for this industry. In comparing the results for the telephone industry with those for the electric utility industry, substantial differences in technological characteristics and in the time form of lagged response of net investment are found.

Regulated utilities and equipment manufacturers' conspiracies in the electrical power industry

Abstract: The paper demonstrates that only with some form of reproduction cost valuation for rate base capital is it possible that the regulatory process might encourage electrical utilities to cooperate or acquiesce with a manufacturers' conspiracy to increase equipment prices. Based on the process function for steam-electric generation developed in the paper, a monopolistic utility subject to rate-of-return regulation using original cost valuation will always have a more profitable alternative than paying conspiratorially inflated equipment prices. Empirically, the acquisition prices for steam-electric generating units purchased by utilities were higher during a "conspiracy" period, 1956-1959 than during the adjacent years, 1954-1955, 1960-1961. Although the statistical results were somewhat ambiguous, it could not be concluded that the type of rate-base valuation scheme applicable to each utility made a significant difference either in the level of prices or in the increase in prices for similar generating units.