Showing papers in "The Review of Economic Studies in 1982"

Relaxing price competition through product differentiation

Abstract: Central to the problem of providing adequate foundations for the analysis of monopolistic competition, is the problem of describing market equilibria in which firms choose both the specification of their respective products, and their prices. The present paper is concerned with a-very particular-model of such a market equilibrium. In this equilibrium, exactly two potential entrants will choose to enter the industry; they will choose to produce differentiated products; and both will make positive profits.

A Theory of Wage Dynamics

Abstract: A dynamic, equilibrium model of long term (implicit) labour contracts under incomplete but symmetric information is developed. Workers are assumed to be risk averse and of unknown ability or productivity. Risk neutral firms learn, as do workers, about each worker's productivity by observing the worker's output over time. It is shown that equilibrium contracts provide for wages which never decline with age and increase only when the worker's market value increases above his current wage. In addition to characterizing the equilibrium wage contract, we also derive some of its implications for the behaviour of aggregate wages across various groups of workers. These implications explain some findings in the recent empirical literature on ageearnings profiles. In particular our model can explain why earnings may be positively related to experience even after controlling for productivity, as some empirical studies have indicated.

Wage Determination and Efficiency in Search Equilibrium

Abstract: The concept of a competitive market is a major tool in the analysis of economists. In the simplest version of a market, resource allocation responds instantly to changes in parameters, leaving no room for frictional unemployment. One response to the unreality of this implication has been to introduce spatially distinct markets, with unemployment as workers move between markets. As modeled by Lucas and Prescott (1974), workers who are not moving are not unemployed. An alternative response is contained in the sizeable fixed price equilibrium literature, where it is assumed that prices do not change to clear markets in the short run. In contrast, the conceptual starting place of this analysis is to drop the idea of a market. Rather than markets being the mechanism by which workers and jobs are brought together, it is assumed that there is a search process which stochastically brings together unemployed workers and vacant jobs pairwise. It is taken as axiomatic that the process takes time and so involves foregone output. It is assumed that a worker and a job brought together by the search process negotiate a wage, with instantaneous negotiation. Thus, the only frictions in the model are in the search process, with wages flexible. Actual search and negotiation processes are complicated and would be difficult to model in detail. Here we make numerous simplifying assumptions to permit explicit solution of equilibrium variables and easy analysis of their efficiency properties. The focus of the analysis is the efficiency of the incentive to enter the labour market. That is, we compare the lifetime expected present discounted value of earnings of a new worker with the social marginal product of that worker. The comparison depends critically on the bargaining solution and on the nature of the search technology. Generally, equilibrium is not efficient because of search externalities. The sources of the externalities are easy to see. The presence of an additional worker makes it easier for vacancies to find workers and harder for other workers to find jobs. The wage negotiation, however, reflects the relative bargaining powers of workers and jobs. Only in special cases will the balance of bargaining powers result in a wage which reflects the balance of search externalities as well as the value of output directly produced. The analysis identifies cases where the incentive for entry is too large or too small. This efficiency analysis complements other efficiency analyses of search intensity, job-quitting, and job-taking (Diamond (1981), Diamond and Maskin (1979, 1981), and Mortensen (1979, 1981)). These latter papers have considered markets with equal numbers of jobs and workers. This paper focuses on the implications of unequal numbers

The Comparison of Multi-Dimensioned Distributions of Economic Status

Abstract: The literature on inequality measurement has been largely concerned with single-dimensioned indicators. This paper explores some of the issues which arise when there are several dimensions to inequality, and these are not readily reduced to a single index, concentrating particularly on the two-dimensioned case. We make use of results on multi-variate stochastic dominance in portfolio theory, extending these and applying them to the measurement of inequality. The use of the dominance conditions is illustrated by an application to the international distribution of income and life expectancy.

Serial Correlation and the Fixed Effects Model

Abstract: This paper generalizes the Durbin-Watson type statistics to test the OLS residuals from the fixed effects model for serial independence. Also generalized are the tests proposed by Sargan and Bhargava for the hypothesis that the residuals form a random walk. A method for efficient estimation of the parameters is also developed. Finally, an earnings function is estimated using the Michigan Survey of Income Dynamics in order to illustrate the uses of the tests and the estimation procedures developed in this paper.

Some Approaches to the Correction of Selectivity Bias

Abstract: This article addresses the issue of specification of econometric selectivity models and suggests approaches for the correction of selectivity bias Our approaches provide ways to specify selectivity models without the assumption of multinormal distribution Some flexible function forms for the correction of selectivity bias in the regression equation are derived All the models considered can be estimated by simple consistent two stage methods Our approaches provide simple procedures for the testing of selectivity bias without imposing restrictive distributional assumptions and also tests for the normality assumption

True and Spurious Duration Dependence: The Identifiability of the Proportional Hazard Model

Abstract: Lancaster and Nickell (1980) have argued that in the proportional hazard model the effects of time dependence (true duration dependence) and unobserved sample heterogeneity (spurious duration dependence) cannot be distinguished. We show that both effects can be distinguished if the model allows for observed explanatory variables in the hazard. We also discuss the application of our result to practical situations.

Estimation of a Labour Supply Model with Censoring Due to Unemployment and Underemployment

Abstract: This study proposes and implements a method of labour supply estimation which is appropriate when the sample contains unemployed and underemployed workers. The estimation method consists of excluding unemployed and underemployed workers from the sample and then using (to avoid selection bias) an extension of Heckman's approach to the case where two correlated selection rules generate the sample. Hausman's specification test is then used to determine whether ignoring constrained workers has led to biases in traditional labour supply estimates, and the empirical results suggest that previous estimates of several important parameters are biased. Since the biases go in the direction that would be predicted by the hypothesis that the unemployed and underemployed are constrained, the results support this hypothesis.

Trade and Protection with Multistage Production

Abstract: This paper analyses trade in manuf acutured goods that are produced via a vertical production structure with many stages, where some value is added at each to an intermediate product to yield a good-in-process ready for the next stage. We consider the stage at which a good is traded to be an economically endogenous variable, with comparative advantage determining the pattern of production specialization by stages across countries. We study how endowment changes and policy shifts move the margin of comparative advantage, which thus provides a channel for resource allocation adjustment that is additional to the usual ones of factor substitution and changes in the quantity of output.

The Inefficiency of the Stock Market Equilibrium

Abstract: This paper establishes that when there is not a complete set of markets but more than one commodity the stock market equilibrium will not in general be a constrained Pareto optimum. The economy will lack both the property of exchange and production efficiency. Necessary conditions which must be satisfied if the economy is to be a constrained Pareto optimum for all technologies are derived; if all individuals have identical, homothetic indifference maps, then either there must be unitary price elasticities (so there is no effective risk) or all individuals must have the same degree of risk aversion (so there is no trade on the stock market).

The Efficient Estimation of Econometric Models with Rational Expectations

Abstract: The efficient estimation of econometric models with rational expectations by the substitution method usually entails the use of a non-linear simultaneous equations estimator and hence is not very attractive computationally. It is shown that for a wide class of problems efficient estimates can also be obtained with standard estimation methods if instead an errors in variables approach is used. For many other problems, although not providing fully efficient estimates because rationality is not imposed, the errors in variables method will still have a strong appeal because otherwise it uses all of the structural information in the model; unlike the substitution method, when an incomplete information set is used, it guarantees consistent estimates; and it is easy to compute.

Energy and Resource Allocation: A Dynamic Model of the “Dutch Disease”

Abstract: It is well known that a domestic resource discovery gives rise to wealth effects that cause a squeeze of the tradeable good sector of an open economy. The decline of the manufacturing sector following an energy discovery has been termed the "Dutch disease", and has been investigated in many recent studies. Our model extends the principally static analyses to date by allowing for: (1) short-run capital specificity and long-run capital mobility; (2) international capital flows; and (3) far-sighted intertemporal optimizing behaviour by households and firms. The model is solved by numerical simulation.

Information and Incentives: The Agency Information Problem

Abstract: This paper considers the use of imperfect information for risk sharing and incentive purposes when perfect observation of actions and outcomes is impossible, making complete contracting infeasible. The incentive-insurance problem is defined to consist of two parts: the choice of an information system and the design of a sharing rule based on the information system. A generalized agency model is formulated to analyse this problem. The agency models of Ross (1973a, b), Wilson (1968), Stiglitz (1974), Mirrlees (1976), Harris and Raviv (1979), Holmstrom (1979) a.o. appear as special cases of the generalized model. The analysis focuses on the value of information in the agency information problem. The set of information systems which are valuable—i.e. improve risk sharing and incentives in a Pareto sense—is characterized. A problem-independent ranking of information systems for the agency information problem is then characterized under the assumption that the agent's preferences are additive in money and actions. The ranking may be viewed as a generalization of Blackwell's ranking of information systems for decision problems, to this particular game. When the agent's risk preferences depend on his choice of action, on the other hand, it is shown that the Blackwell ranking may be invalid. Randomized incentive schemes are shown to be efficient when the incentive effect of risk is positive and sufficiently large relative to the absolute risk aversion of the partners.

Input Price Shocks and the Slowdown in Economic Growth: The Case of U.K. Manufacturing

Abstract: This paper provides a theoretical and empirical analysis of the effects of input price shocks on economic growth, with a focus on United Kingdom manufacturing in the 1970s. The theoretical model predicts a discrete decline in output and productivity after an input price rise, and a longer-run slowdown in productivity growth, real wage growth, and capital accumulation. These features characterize the United Kingdom and most other OECD economies after 1973. The empirical results confirm the important role of input prices in recent U.K. adjustment, but also point to an important role for other supply and demand factors. Two types of explanations have been offered for the sharp deterioration in U.K. economic performance in the past decade, focusing respectively on demand and supply factors. A standard Keynesian view holds that macroeconomic demand management has been either too expansionary or too contractionary, and that rising unemployment and falling output reflect the burden of anti-inflationary policies. An alternative view holds that various supply shocks are the main source of the poor output performance. In this interpretation, higher raw material prices (particularly oil), competition from the newly-industrializing countries (NICs), and perhaps an independent decline in productivity growth, all have lowered output growth and raised unemployment.

On the Sign of the Optimum Marginal Income Tax

Abstract: This paper studies a central aspect of optimal income taxation as modelled in Mirrlees' original paper on the topic (identical leisure/consumption preferences, qualitatively homogeneous "skills" in production), namely, whether given concave utilitarianism alone the optimal marginal income tax will be non-negative. A well-known positive answer to this question (in weak inequality form) was given in the said paper which, however, we show requires additive separability of Individual utility (in the ordinal and cardinal senses). Our main result here is to derive the required (strict) positivity of the marginal tax under weak conditions, slightly wider than noninferiority of consumption and leisure, with preferences otherwise arbitrary.

The Intertemporal Substitution Model of Labour Market Fluctuations: An Empirical Analysis

Abstract: The paper uses two approaches to study whether aggregate fluctuations in employment and unemployment may be explained within a market clearing framework as intertemporal substitution in labour supply. First, log-linear equations for labour supply and unemployment are estimated using a forecasting model to measure wage and price expectations. Second, a utility function is used to derive and estimate an equation for labour supply as a function of the current real wage and consumption. The influence of expected future real wages and interest rates is captured by the consumption variable. The empirical results do not support the intertemporal substitution model.

Corrigendum on A Life Cycle Model of Female Labour Supply

Abstract: In the empirical work in our article on the intertemporal substitution of leisure time for married women (Heckman and MaCurdy (1980)) we inadvertently constrained the estimated intertemporal substitution elasticity to be too high. Since this parameter plays a prominent role in discussions of equilibrium models of the business cycle and since our empirical work has been cited in discussions on this topic (e.g. Hall (1980)), we would like to present a corrected set of empirical results for our model. The period t utility function adopted in this note is (in the notation of our original paper, equation (15))

The Determinants of Occupational Success in Britain

Abstract: This paper is concerned with measuring the true impact of certain human capital variables on an individual's occupational position. The particular variables which are analysed are training, qualifications and spells of sickness and unemployment. The longitudinal nature of the data enables us to control for all relevant individual attributes which remain fixed over the period of the sample. This is vitally important because these attributes are strongly correlated with the variables of interest and would seriously corrupt estimates derived from a single cross-section. A method of generating consistent estimates (as N -, oo, T fixed) for a dynamic model with fixed effects is also illustrated.

Prices and Qualities in Markets with Costly Information

Abstract: This paper extends the seminal work of Akerlof, and Salop and Stiglitz in two directions: (i) the sellers can select both the selling prices and quality levels of their good, and (ii) the buyers can acquire price/quality information about individual sellers at a cost. We observe multiple price/quality combinations in equilibrium, which depend upon the distribution of information costs of consumers and upon whether quality, or price, or both are costly observable. Welfare comparisons of equilibrium are considered. We show that welfare will be greater when price advertising is permitted.

Labour Force Participation: Timing and Persistence

Abstract: This paper examines the relative importance of timing and persistence elements in explaining cyclical fluctuations in labour supply. Data from the natural experiment provided by World War II and cross-sectional data on American local labour markets, as well as aggregate time-series data are used in the empirical work. We find little evidence that timing effects play an important role in labour market dynamics. The evidence suggests that views emphasizing persistence are more accurate, and that previous employment tends to raise the probability of subsequent employment. Much of the development of applied economic theory within the past 25 years has emphasized the importance of viewing economic decisions in a life cycle context. Consumption decisions are today frequently viewed as being determined by wealth or permanent income. The human capital revolution has brought life cycle considerations to the forefront of modern labour economics. While the life cycle dynamics of labour force participation decisions have important implications for macroeconomic theory and policy, they have received relatively little empirical attention. With the notable exceptions of Lucas and Rapping (1969) and Hall (1980), none of the large body of work on cyclical fluctuations in employment has explicitly relied on a dynamic model of labour supply.' This paper uses several types of data to examine two elements of participation dynamics. The first is the aspect of "timing" which is implicit in the work of Lucas and Rapping, and in Mincer's (1966) early discussion of hidden unemployment. The timing argument, which is presented most explicitly in Ghez and Becker (1975), holds that leisure is easily substitutable across periods. Hence relatively small transitory movements in the perceived real wage or real rate of return can have large effects on the path of labour supply as individuals time their participation to coincide with periods of high transitory wages. On the other hand, permanent changes, because they do not affect the timing decision, are expected to have a much smaller effect on participation. It is this view of labour supply which underlies new classical macroeconomic models. The dependence is made explicit in Lucas (1975), who claims that "what we do know indicates that leisure in one period is an excellent substitute for leisure in other nearby periods". The ability of classical macroeconomic models to explain fluctuations in employment depends on the presence of strong intertemporal substitution effects. Unless

Some Non-Nested Hypothesis Tests and the Relations Among Them

Abstract: In this paper we discuss several statistical techniques which may be used to test the validity of a possibly non-linear and multivariate regression model, using the information provided by estimating one or more alternative models on the same set of data. We first exposit, from a different perspective, the tests proposed by us in Davidson and MacKinnon (1981a), and discuss modified versions of these tests and extensions of them to the multivariate case. We then prove that all these tests, and also the tests previously proposed by Pesaran (1974) and Pesaran and Deaton (1978), based on the work of Cox (1961, 1962), are asymptotically equivalent under certain conditions. Finally, we present the results of a sampling experiment which shows that different tests can behave quite differently in small samples.

Time Series Representations of Economic Variables and Alternative Models of the Labour Market

Abstract: Accepting the hypothesis that the time-series "facts" of the aggregate labour market may be summarized by the linear autoregressive and moving average representations of wages, prices, unemployment, and interest rates implies that a useful theory ought to lead to predictions about these representations. Following this approach, this paper first catalogues many of the time-series facts about the aggregate labour market and then compares them against alternative models of the labour market based on the intertemporal substitution and staggered contract hypotheses.

"Learning by Doing" and "Investment in Training": A Synthesis of Two "Rival" Models of the Life Cycle

Abstract: This paper provides a theoretical synthesis of recent discussions of "learning by doing" and "investment in training" as alternative forms of human capital accumulation. These theoretical notions relate to essentially different phenomena; in particular, pace Becker and Mincer, "investment in training" does not completely encompass "learning by doing". The paper then develops a model in which human capital accumulation occurs via both "training" and "learning by doing". The joint training-learning model, since it is more general then "pure" models in which all accumulation occurs via either training or learning, avoids certain restrictive and seemingly implausible implications of either kind of "pure" model. However, the joint model also has implications that, while compatible with stylized facts about the life cycle, are sharper than those of either kind of pure model. (For example, the joint model implies that market time and earnings must rise early in the life cycle, while neither pure model without "corners" does so.) Finally, the notion of learning by doing provides a rationale for an empirical finding that has recently received attention, to the effect that the rate of depreciation of human capital is not constant, but rather depends on the extent to which it is used in market activities.

The estimation and interpolation of inequality measures

Abstract: Alternative methods of computing estimates of inequality measures from grouped data are critically examined in terms of their theoretical and empirical properties. The use of a simple "split-histogram" technique of interpolation is explained and supported. Theoretical and empirical support is also provided for the "3/3- rule"-a simple computational procedure for a point estimate of an inequality measure derived from its standard grouping bounds.

Invention and Innovation Under Alternative Market Structures: The Case of Natural Resources

Abstract: This paper examines the interactions between market structure and resource allocation over time when there is endogenous technical progress. The structures considered are a planned economy, pure monopoly, and competition with patent rights. In an efficient allocation the date of invention coincides with the date of innovation (the date at which technology is used). This is also true with a pure monopoly, but monopoly retards technical progress relative to the efficient level. Competition for patents rights to a new technology results in excessively rapid technical progress if the resource endowment of the economy is sufficiently large. Also, competition may lead to "sleeping patents" where invention strictly precedes the date of innovation.

Causes of the Current Stagflation

Abstract: Since 1975 labour slack has been unusually high in the OECD countries, and yet inflation has not diminished. The less favourable mix of unemployment and rate of change of inflation (which we call stagflation) is explained by a fall in the feasible rate of growth of real wages unmatched by a reduction in the constant term in Phillips curve. To investigate this mechanism, conventional wage and price equations are estimated for 19 countries and then used for simulation. Stagflation has been caused in roughly equal amounts by rising relative import prices and by the fall in the rate of productivity growth. In the basic model the Phillips curve is assumed not to adapt to falls in feasible real wage growth, but in a final section an adaptive wage equation is estimated, which confirms that the process of adaptation is slow.

Inventory and Price Behaviour

Abstract: The point of this paper is that inventory adjustment attenuates downward pressure on price when realized demand is low because firms accumulate inventory hold-overs, speculating that demand will be stronger in the succeeding period. When realized demand is high the firm draws down its inventories until a "stock-out" occurs and price rises to clear the market.

Search and Consumer Theory

Abstract: A consumer faces list prices for commodities, but can buy one at a discount. Discounts vary randomly between sellers. The number of quotations sought depends on list prices, search costs and wealth. This function is homogeneous of degree zero, and, provided some sufficient conditions are satisfied, is; increasing in wealth; decreasing in search cost; independent of the list price of the discounted commodity if indirect utility is multiplicatively separable; increasing in the list price if the commodity is a necessity; increasing in the list price of substitutes. Slutsky's equation is generalized to include search.

Imperfect Price Discrimination and Welfare

Abstract: We develop a model in which a monopolist uses differences across consumers in their valuation of time to imperfectly price discriminate. Though it is customary to analyse price discrimination problems by the calculus of variations after postulating a continuum of types, we assume a finite number of types and exploit the geometry and duality of the contract set and the structure of the programming specification. We analyse in detail the qualitative properties of the model's solution and show by construction that our results exhaust the implications of the model for equilibrium contract pairs. We show that imperfect discrimination is not bounded in welfare terms between perfect discrimination and single-price monopoly and that the deadweight loss, consumer surplus and output comparisons between single-price monopoly and imperfect discrimination are ambiguous.

Testing for Sample Selection Bias

Abstract: A simple regression test of the null hypothesis of no sample selection bias has been suggested by J. J. Heckman. Because of its computational simplicity, this test is widely used by applied researchers. This paper shows that Heckman's test is equivalent to the Lagrange multiplier test of the null hypothesis. This allows us to readily deduce that the simple regression test also has desirable large sample properties.