Cost Elasticity Research Articles

Separating Signaling Equilibria Under Random Relations Between Costs and Attributes: Discrete Attributes

We identify conditions for separating signaling equilibria where discrete attributes are randomly related to a continuum of costs. A necessary condition is the ordering of the cost distributions conditional on attributes by first order stochastic dominance. A necessary and sufficient condition is the ordering of the cost distributions conditional on attributes by the monotone likelihood ratio property. An equivalent necessary and sufficient condition is the monotone ordering of the cost elasticities of these distributions.

Elasticity based pricing rules: a cautionary note

The inverse elasticity rule is all too often described in a way that implies a myopic application, sometimes with a numerical example with input values for price elasticity of demand and marginal cost thus determining profit maximizing price. Conversely, the rule's shortcomings are not given deserved attention. This is unfortunate, as the rule may be adopted at face value, which will lead to erroneous pricing. If marginal cost and price elasticity depend on price, as is usually the case, a myopic application of the rule will, in most cases, lead to a bypassing of optimal price; if the initial price were too low, then the prescribed price would be too high, and vice versa. Continued myopic use may even lead to divergence from the profit maximizing price. Only if both price elasticity of demand and marginal cost are constant, which is rarely the case, will the rule return the optimal price.

Fair wages in a New Keynesian model of the business cycle

We build a New Keynesian model of the business cycle with sticky prices and real wage rigidities motivated by efficiency wages of the gift exchange variety. Compared to a standard sticky price model, our Fair Wage model provides an explanation for structural unemployment and generates more plausible labor market dynamics—notably accounting for the low correlation between wages and employment. The fair wage induced real wage rigidity also significantly reduces the elasticity of marginal cost with respect to output. The smoother dynamics of real marginal cost increase both amplification and persistence of output responses to monetary shocks, thus remedying the well-known lack of internal propagation of standard sticky price models. We take these improvements as a strong endorsement of the addition of real wage rigidities to nominal price rigidities and conclude that the fair wage extension of this paper constitutes a promising platform for an enriched New Keynesian synthesis.

Fair Wages in a New Keynesian Model of the Business Cycle

We build a New Keynesian model of the business cycle with sticky prices and real wage rigidities motivated by efficiency wages of the gift exchange variety. Compared to a standard sticky price model, our Fair Wage model provides an explanation for structural employment and generates more plausible labour market dynamics, notably accounting for the low correlation between wages and employment. The fair wage induced real wage rigidity also significantly reduces the elasticity of marginal cost with respect to output. The smoother dynamics of real marginal cost increase both amplification and persistence of output responses to monetary shocks, thus remedying the well-known lack of internal propagation of standard sticky price models. We take these improvements as a strong endorsement of the addition of real wage rigidities to nominal price rigidities and conclude that the fair wage extension of this Paper constitutes a promising platform for an enriched New Keynesian synthesis.

Demand, cost elasticities and pricing benchmarks in the hypothetical monopoly test: the consequences of a simple SSNIP

The hypothetical monopoly test for market power is translated into an operational ‘formula’ involving cost and demand elasticities. The importance of the choice of the pricing benchmark is emphasized - and of why it is important to incorporate an assessment of cost structure when conducting such tests. Recent work in the EU and the UK (notably in Telecoms) has ignored cost structures when making assessments of market power. It is shown in this article that ignoring cost structure leads to bias in that market power will often be found when in fact none is present.

Modelling International Travel Demand from Singapore to Australia

ABSTRACT Prior to the recent Asian currency and economic crises, tourism from Asia had rapidly become Australia's major tourism export industry. Tourists from Singapore, which is Australia's fifth major market, represented 6% of international tourist arrivals to Australia in 1996. The average annual growth rate of tourist arrivals from Singapore of around 20% over 1990–96 far exceeded the 10.5% average annual percentage growth rate of all tourist arrivals to Australia over the same period (Australian Bureau of Statistics 1997). Despite the Asian currency and economic crises in 1997–98, tourist arrivals to Australia from Singapore have continued to grow slowly. It is imperative to consider the economic factors influencing international tourism demand for Australia by Singapore, and to undertake a sensitivity analysis of tourist arrivals to changes in the factors. The purpose of the paper is to estimate the income, price and transportation cost elasticities of inbound tourism from Singapore to Australia using seasonally unadjusted quarterly data. Initially, estimation is undertaken using ordinary least squares. Given New Zealand's proximity to Australia, it is also useful to determine using a single-equation model if Australia and New Zealand are substitute or complementary destinations for Singaporean tourists by examining the effects of the relative price changes in New Zealand and Australia on international travel demand for Australia. In addition, seasonal influences are examined using the single-equation model. The OLS estimates of the appropriate single-equation model are also compared with the estimates obtained using the cointegration method in Lim and McAleer (2001).

A Semi‐nonparametric Approach to the Demand for UK Monetary Assets

We estimate an asymptotically ideal model of the demand for UK personal sector monetary assets. We use data that are consistent with utility‐maximizing behaviour, and find that UK monetary assets are generally substitutes in use. The estimated elasticities of substitution during the 1980s and the early 1990s indicate that a relatively broad monetary aggregate should be used in economic studies. The results also suggest that any policy based on interest or user cost elasticities of substitution between financial assets should be based on the Morishima elasticities, as the Allen–Uzawa calculation can give misleading results.

A passenger travel demand model for Copenhagen

The passenger travel demand model for Copenhagen is a state-of-practice nested logit model in which the sub-models––i.e. generation, distribution and mode choice models––are connected via the measure of accessibility. The model includes in its structure a large set of explanatory variables at all three levels. The model validity is strongly asserted by the fact that the forecasting results for 2000 exhibit a very good fit to the observed car and public transport traffic, and that some model results (e.g. car driving cost elasticity) match the results from other well established models well. This paper aims to provide a detailed description of the model, which can be used as a guide to the future development of similar models. Also, an application of the model in a study of road pricing in Denmark is described. This gives the reader an idea of how such a policy measure can be modelled as well the plausible magnitude of changes caused by a road pricing system.

Dynamic Factor Demand Model with Network-type Stock and Externality

This paper focuses in the existence of quasi-fixed inputs and externality in the dynamic factor demand model of cost function. At first, we shed light on the degree of scale economies including the quasi-fixed inputs and externality in both static and dynamic models by theoretically. The degree of scale economy in the dynamic model was already introduced by Morrison (1985) (Journal of Business & Economic Statistics) and Morrison/Siegel (1999) (American Economic Review) by geometrically, We introduce it by algebraically. Next, the dynamic factor demand model with quasi-fixed inputs and externality is empirically estimated using translog cost function of fixed effect panel model. The results of estimation give some consequences. (1) The signs of cost elasticity of stock other than network type, network type stock and externality represent the results, which are theoretically required. (2) The effect of the network type stock to the cost function is larger than that of the stock other than network type. (3) Externality, which supports the input factor, is effective to the decreasing of the total cost.

Estimating the Long-Run User Cost Elasticity

The user cost elasticity is a parameter of central importance in economics, with implications for monetary policy, macroeconomic models, tax policy, growth and many other areas. If the supply curve for capital is upward sloping and shocks to demand area important (as they are likely to be over the business cycle), estimates of the user cost elasticity that rely on high-frequency movements in the variables will tend to be biased. This paper applies cointegration techniques to a small, open economy. The combination of exogeneity of user cost implied by the flat supply of capital curve for a small, open economy and appropriate correction for small sample bias yields an estimate of the long-run user cost elasticity which is about 75% larger (in absolute value) than the best existing estimate. In addition, the paper makes three further contributions: accounting for increases in depreciation (due to dramatic increases in computer use), estimating the long-run user cost elasticity for structures and the total capital stock, and disentangling the effects of capital goods prices, the real interest rate, and taxes.

Estimation on Regional Benefit and Optimal Level of Road Capital Stock

This paper measures the regional benefit of road investment in Korea, using the translog cost functions of the manufacturing industry for the four macroregions of Seoul Metropolitan Area, South-Eastern Area, South-Western Area, and Central Area. This paper shows that the road capital contributes significantly to the productivity of the manufacturing industry in the sense that the magnitude of the road capital stock elasticity of the production cost at the national level is -0.0124. The net social rate of return for all regions is higher than the yield of corporate bonds, which implies that the road capital stock is undersupplied in Korea. The ratio of optimal to actual road capital stock declined from 1986 to 1991, and then increased in all regions except Seoul Metropolitan Area since 1992. In order to generate economic efficiency and regional equality, it is necessary to increase road capital investment in the less developed regions of Korea, such as the South-Western Area and the Central Area.

Economics of Scale in the Retail Superannuation Funds in Australia

Using a translog cost function, we examine the extent to which economies of scale exist for retail superannuation funds in Australia for 1999 and 2000. We find that the average cost elasticity for Australian retail superannuation funds is equal to 1.0. This means that percentages cost increases are equal to the same percentage increases in assets for the retail superannuation funds in general. Variations in fund size and fund objective show variations in cost elasticities of funds. We find economies of scale for funds greater than $30 million in size. Average cost elasticity also shows economies of scale for domestic debt and multisector funds.

Size, cost, and productivity in the meat processing industries

AbstractTechnology and technical change in the meat processing industries are examined in a cost function framework. Consistent with other studies, we find productivity growth rates to have declined in the past several decades. Nevertheless, growth has consistently been positive and has responded only modestly to the business cycle and to capital prices. Productivity‐induced downshifts in unit cost curves have boosted cost elasticities, enhancing incentives for firm and plant‐size growth. Rising capital shadow prices suggest the quality of capital has grown relative to that of labor and materials. Technical change appears to be capital‐using and material‐saving, counteracting the generally capital‐saving and material‐using effects of output expansion. [EconLit Citations: D24, L66, O30]. © 2002 Wiley Periodicals, Inc.

The costs of natural gas distribution pipelines: the case of SCGM, Québec

The capital costs of natural gas distribution pipelines account for 70% of the rate base of SCGM, the main local distribution utility in the province of Québec. In allocating these capital costs to consumer groups, the regulatory process divides them into an access fee which is supposed to represent the costs of making available natural gas, and a per unit fee reflecting the costs of the capacity which they use. We estimate a cost function to probe whether distribution capital costs can be broken down into these two parts by applying regression analysis to a unique set of 131 observations related to natural gas extension projects in four Québec regions. It is found that capital costs are not separable into linearly additive constant and variable components, that the cost elasticity with respect to maximum daily demand is small, and that the cost elasticity with respect to pipe length is slightly less than one. On the basis of these findings we conclude that the regulatory process assigns too large a share of distribution capital costs to use relative to access fee.

The Effect of Public Infrastructure on the Private Productive Sector of Spanish Regions

In this paper we analyze the effect of infrastructure on the cost and productivity performance of the private productive sector of Spanish regions over the period 1980–1993. We use a dual approach based on cost functions that allows us to recover the usual parameters estimated with production functions. In addition, we obtain rates of return and cost elasticities of production factors at the regional level. Our framework explicitly considers that some factors are quasi‐fixed and their volume can differ from their optimal endowment levels. Our results indicate that the public sector has contributed significantly to enhance productivity and reduce costs in the private sector of almost every Spanish region. Nevertheless, there is still scope for the government to continue its investment efforts, given that there remains an appreciable gap between observed and optimal public capital, and we find that in the long run, public capital promotes private investment.

Access to and competition between airports: a case study for the San Francisco Bay area

In this paper (nested) logit models that describe the combined access mode-airport-choice are estimated. A three level nested logit model is rejected. A two level nested logit model with the airport choice at the top level and the access mode choice at the lower level is preferred. From the estimation results, it is concluded that business travelers have a higher value of time than leisure travelers. In the (conditional) access mode choice, leisure travelers have a higher access cost elasticity (in absolute value), while business travelers have a higher access time elasticity (in absolute value). In general, access time is of large importance in the competition between airports in a region.

Roundwood supply in Norway: micro-level analysis of self-employed forest owners

This paper presents a short-run roundwood supply analysis of self-employed Norwegian forest owners, based on a two-period utility maximising consumption-savings model. The supply function was estimated by applying the Tobit model on an unbalanced panel of approximately 160 Norwegian farmers, from 1976 to 1997, representing a total of 3413 observations. Simultaneity between the single forest owner's harvesting level and his individual tax rate was allowed by estimating simultaneous equations Tobit models. The current roundwood price and standing stock per hectare had significant positive impacts on the supply, while harvesting costs, age of the owner, tax rate and lagged roundwood price (representing expected price) had negative impacts. Price and cost elasticities were relatively sensitive to the prices forecasted for the owners who did not supply roundwood in a given period. These results suggest that price subsidies and operating subsidies, as well as tax relieves, could increase the harvest level, which is considerably lower than the sustainable harvest level. An operating subsidy seems at least as efficient as a price subsidy, while tax reliefs are the least efficient of the three policy means.

Pricing, Production, and Persistence

Though built with increasingly precise microfoundations, modern optimizing sticky price models have displayed a chronic inability to generate large and persistent real responses to monetary shocks, as recently stressed by Chari, Kehoe, and McGrattan [2000]. This is an ironic finding, since Taylor [1980] and other researchers were motivated to study sticky price models in part by the objective of generating large and persistent business fluctuations. The authors trace this lack of persistence to a standard view of the cyclical behavior of real marginal cost built into current sticky price macro models. Using a fully-articulated general equilibrium model, they show how an alternative view of real marginal cost can lead to substantial persistence. This alternative view is based on three features of the supply side of the economy that we believe are realistic: an important role for produced inputs, variable capacity utilization, and labor supply variability through changes in employment. Importantly, these real flexibilities work together to dramatically reduce the elasticity of marginal cost with respect to output, from levels much larger than unity in CKM to values much smaller than unity in this analysis. These real flexibilities consequently reduce the extent of price adjustments by firms in time-dependent pricing economies and the incentives for paying fixed costs of adjustment in state-dependent pricing economies. The structural features also lead the sticky price model to display volatility and comovement of factor inputs and factor prices that are more closely in line with conventional wisdom about business cycles and various empirical studies of the dynamic effects of monetary shocks.

Cost Structure and the Measurement of Economic Performance: Productivity Growth, Utilization, Cost Economies, and Related Performance Indicators

Cost Structure and the Measurement of Economic Performance: Productivity Growth, Utilization, Cost Economies, and Related Performance Indicators By Catherine J. Morrison Paul. Norwell, MA: Kluwer Academic Publishers, 1999. Pp. xiv, 363. $129.95. This book, a revised version of Professor Paul's 1992 monograph, examines the measurement of productivity growth (as a measure of economic performance) from the production and cost function perspectives, and its decomposition into technical change and scale economies components. Productivity growth is measured as the growth rate in output (or outputs in the case of multiple outputs) minus a weighted average growth rate in inputs. Technical change occurs when a larger maximum quantity of output can be produced from a given quantity of inputs. From the cost side, technical change is measured by the rate of decline in total cost over time, accounting for other factors that could affect total cost. Scale economies refer to the proportional change in output due to a change in inputs by the same proportion, all other factors held constant. From the cost side, scale economies are typically measured using the total cost elasticity with respect to output. The total cost elasticity can be used to obtain an accurate measure of scale economies when there is one output, exogenous input prices, and all inputs change by the same proportion. The presence of fixed inputs, multiple outputs, endogenous input prices, and other factors affect the cost elasticity independent of output. The computed cost elasticity with respect to output would include these factors, and as a result does not provide an accurate measure of scale economies. Cost economies are referred to as the impact on total cost of a change in output, accounting and adjusting for fixed inputs, multiple outputs, endogenous input prices, and other factors that could affect total cost. The measure of cost economies is the total cost elasticity when these factors are taken into account. The measure of scale economies, computed using the total cost elasticity independent of other factors that can affect total cost, is a component of the measure of cost economies. The author analyzes how externalities, public goods, fixed inputs, regulation, and other factors can affect production cost, productivity growth and its components, and also how to adjust the measures of productivity growth and its components from the production and cost function perspectives to account for these various factors. A description of the chapters in the text is listed below. Chapters 1 and 2 provide a good and thorough discussion of productivity growth and technical change from the production and cost side perspectives, single-factor and multifactor measures of productivity growth, and the problems encountered with each type of measure. The author also includes a discussion on the determinants of technical change and testing whether technical change is input specific. Chapter 3 focuses on measuring the scale economy component of productivity growth when there are fixed or quasi-fixed inputs, which in turn brings about a discussion on capacity utilization. The author develops production and cost side (dual) measures of capacity utilization. The chapter also describes how to adjust measures of productivity growth when adjustment cost occurs when quasi-fixed inputs deviate from their steady-state values and capital characteristics such as quality, energy efficiency, and vintage are incorporated into the production and cost functions. Chapter 4 describes short-run and long-run measures of cost economies, primarily from the cost side, when there are multiple outputs, fixed inputs, and endogenous input prices. With multiple fixed inputs or endogenous input prices, a method is presented for incorporating these factors to measure a long-run total cost elasticity with respect to output. Chapter 5 analyzes how external factors, such as public capital expenditures, education, research and development, capital-specific technology, and human capital, can affect production cost and economic growth. …

Optimal timing of a real estate development under uncertainty

This paper recasts the land development problems of Williams (1991) and Quigg (1993) by explicitly dealing with the effects of scale elasticity of unit rental and unit construction cost in a real estate project. Two different diseconomies of scale constraints are imposed on the rental and cost variables. We assume a concave function for the rental variable with respect to the scale of development. Whereas, on the cost side, the diseconomies of scale effect of the variable component of the construction cost is incorporated via a elasticity of scale factor that is larger than unity. The comparative statics simulated positive relationships between the premium that keeps the option of waiting to develop alive and the volatilities of the unit rental and unit construction cost. It was also found that the cost elasticity of scale and the financing cost are factors that increase the premium of the waiting option, whereas, the rental yield factor reduces the incentive of waiting. A high rental yield tends to expedite a development project because the opportunity cost of not developing the land is high. In the case analysis involving a vacant land of 8,000 square meters at Spitafield, East London, a unit rental of £267.2 per square meter (psm) is obtained, which would breakeven a cash flows of the project when the traditional “invest now or never” assumption is made. Compared with the optimal unit rental of £677.0 psm estimated by the real option model, the traditional DCF results tend to accept the feasibility of the real estate project too early and at too low a cut‐off rental.