Imperfect Foresight Research Articles

Vertical Integration and Demand Variability

FLUCTUATIONS in demand, and uncertainty due to imperfect foresight regarding these fluctuations, are expensive. Short-run fluctuations force sellers to hold inventories, to adopt costly production techniques, and/or to mitigate the effects of fluctuations by adjusting prices or other terms of sale. Long-run fluctuations may lead to excess capacity that cannot be easily liquidated, and/or to the need to adjust price or other terms of sale. Vertical integration by any means-whether by ownership or long-term contractbetween suppliers and users may reduce demand variability as felt by suppliers. But, vertical integration has costs that dealing in the market may avoid. Profit maximizing firms will integrate to the point where the marginal benefits of further integration equal the costs [51. One expects, therefore, vertical integration to be relatively great where it can greatly reduce demand variability felt by suppliers, and where the costs of variability and uncertainty are high [ I I. In this paper I state three simple, but previously neglected, principles for determining the effect of vertical integration on demand variability felt by individual suppliers in a market with many suppliers.' Polar case models and a theorem show their validity and give the conditions under which integration reduces demand variability felt by individual suppliers. The determinants of the reductions, if any, are also given.2 The usefulness of the principles and theorem is shown in two ways. (i) The principles and theorem are consistent with, and make more precise, prior theory about the power of large buyers. (2) They permit plausible explanations of vertical integration movements difficult to explain on other grounds. One example discussed is a controversial vertical integration movement in the U.S. cement industry

Rate of Growth Effects on Aggregate Savings: Further Analysis

The basic question investigated in this paper is whether or not individual saving for retirement and (possibly) bequests can generate aggregate rates of accumulation of capital close to those which are observed. A quite understandable reaction to this question is that it was disposed of many years ago by Modigliani and Brumberg [1], [2], when they showed with a very simple model of the consumers' lifetime income process that rates of savings akin to those of the US could be generated using US demographic data. It is important to note, however, that the model which Modigliani and Brumberg use does not assume that the individual has perfect foreknowledge of his future income stream. This forces the individual annually to replan consumption, using each year whatever new information is available on the likely future income path. This periodic replanning assumption has a number of consequences.' From our point of view the most important of these is that it makes aggregate consumption sensitive to the procedure used to forecast future income. Modigliani and Brumberg assume that the individual forecasts future income in the following myopic fashion. At each point of time, wage income till retirement will be the current wages earned at that time. After retirement, of course, wage income will be zero. When productivity growth is taking place, this amounts to the assumption that the individual never learns that income is growing. As M. J. Farrell [3] has pointed out, this is a sufficiently unusual assumption to warrant testing the sensitivity of the model's results to it. Farrell [3], for example, keeps all the other Modigliani-Brumberg assumptions but assumes that the individual correctly foresees the growth of future income, and in this case shows that the model not only yields markedly different predictions of the savings/income ratio but, for a growth rate of 4 per cent, actually yields the prediction that the savings/income ratio will be negative. This possibility had been noted earlier by Modigliani [4]. However, in defence of the myopia assumption, Modigliani argued that even if individuals did correctly foresee a rising income, institutional capital market constraints would prevent them from borrowing against this rising income. Thus the consumption plan chosen would not differ very much from the myopia path. Institutional constraints on capital markets are one thing, however, and assumptions about expectations formation are another. To quote Farrell [3, p. 879]: Ideally some sort of asset constraint should be included in the model, and might give Modigliani the approximation he seeks; but it is of little help to us in choosing between two expectational hypotheses. In this paper we examine the Lifetime Income model under a number of different assumptions both with regard to expectations and with regard to capital market imperfections. In particular we compare aggregate consumption and savings under three different planning regimes, utility maximisation with perfect foresight and perfect capital markets (Model 1), utility maximisation with perfect foresight but borrowing constraints (Model 2) and the original Modigliani-Brumberg case of equal planned consumption in each period but with imperfect foresight of future income (Model 3).

Prix, profit et développement économique. Problèmes de l'optimum global

Prices, profit and economic growth prorlems of the gloral optimum Optimisation problems are now studied either in a partial equilibrium setting, or in highly abstract general theories inapplicable to economic reality. The value of the partial studies is limited by the assumptions they have to make about such things as prices and the behaviour of interest rates. Even greater problems arise if our concern is with medium or long term forecasting for the economy as a whole. If we begin from technological and sociological conditions, a wide range of equally plausible assumptions might be made about the evolution of such matters as technical development, the structure of consumption, external trade, etc. It is therefore necessary to compare the quantitative results that different assumptions ivould give, not in order to derive absolute criteria for policy but to specific questions. The author uses such a procedure to examine the optimisation problems arising, first in an economy with perfect foresight, and then in one with imperfect foresight. In neither case can a firm basis be found for choosing between the different options which any model must leave open. In particular, we are left with two general questions : what system of prices should be used to make volume comparisons ? What interest rate should be used in calculations of present value ? In addition, if forecasting is imperfect, the econometric models we can use must necessarily be very rough, and it becomes impossible adequately to restrict the range of possible assumptions about such matters as the evolution of consumption. The author concludes that it might be possible to provide a firmer basis for forecasting over say, a five-year period, by greater systematisation of technical information. For longer periods, many important decisions must involve a gamble : at best, these decisions, once taken, might themselves be treated as the basis for optimisation calculations.

Capital, Time, and the Interest Rate

ed is indefinitely long, there is the further fact that the accumulation of capital immediately involves effects which change the conditions of accumulation. It is needful to mention specifically only one of these: accumulation and investment must increase the real income of society (if not of the savers, then of others), which will make saving easier, and there is no reason, a priori, why this change alone might not counteract the effect of the reduced incentive to save in the form of a progressively lower rate. Other changes are of course involved which would work in the same direction, and in fact it is an almost purely arbitrary assumption that a reduction in the rate of interest will result in a -lower rate of accumulation, even if everything else were absolutely unchanged. Historically, new demand for capital has opened up rapidly enough to prevent any general fall in the interest rate. The primary fact, oversight of which vitiates most discussion of the theory of interest, is that the only situation of which we have any knowledge in capitalistic society is one in which total investment is growing at a fairly rapid rate; the only time when this is not clearly true is when conditions are dominated by war or the economic disorganisation called crisis, so that the ordinary price relations and controls are inoperative. The heart of a correct theory of interest is the fact, corresponding more or less to infinite elasticity of demand for that the investment market is capable of absorbing savings at the maximum rate at which they are forthcoming, with only a very gradual decline of the rate of return through time, other things equal, and the further fact that changes which do occur in the other things (partly in consequence of the growth of capital, but effects in a historical, not an economic sense) actually prevent any general decline. With opportunity to invest to an indefinite extent and at a practically unvarying rate constantly open, no one will pay more or take less for any sort of loan than the rate obtainable by investment at the margin of capital growth.' The false impression that this quasi-elasticity is fairly limited may be accounted for by failure to consider a theoretical limitation on the notion of an instantaneous market rate already alluded to. It is true that the market cannot instantly adjust itself to rapid, unanticipated changes in the rate of flow of savings into the market without changes in the rate. This is purely a matter of planning and uncertainty and the effect of imperfect foresight. It requires time to plan for investment, and at any moment investment (actual construction of income-bearing goods) is being carried on at a fairly definite rate. If savings suddenly begin to come into the market much more rapidly than the rate planned for (whether correctly or not) by entrepreneurs and promoters in the aggregate, a temporary glut and fall in the rate will follow naturally. And, conversely, if the flow of savil-gs is too slow to carry out the plans actually in course of execution, a sort of distress demand will send the 1 This would be true with little qualification even in a retrograde society, but that is not in point here. This content downloaded from 157.55.39.92 on Wed, 22 Jun 2016 06:52:44 UTC All use subject to http://about.jstor.org/terms 286 ECONOMICA [AUGUST rate upward. Such facts as these undoubtedly enter into Professor von Hayek's confusion regarding the relation between the length of the production process and the analysis of the business cycle. But under no conditions is there a valid basis for arguing that either more investment, of itself, or more rapid investment, need be associated, either with investment in more durable instruments, or with a lengtlhening of the construction period. The University of Chicago. This content downloaded from 157.55.39.92 on Wed, 22 Jun 2016 06:52:44 UTC All use subject to http://about.jstor.org/terms