Strict Pareto Improvement Research Articles

Design and study of hybrid BI insurance contracts with interruption compensation, reward, and penalty under adverse selection

AbstractAiming at the adverse selection problem in the BI insurance market under asymmetric information, this paper designs a hybrid BI insurance contract with interruption compensation, reward, and penalty based on the principal‐agent theory. It is found that regardless of the existence of two or more risk types in the BI insurance market, the hybrid BI insurance contract will be a strict Pareto improvement of the traditional partial insurance contract that is replicated twice. Meanwhile, we validate and extend the above conclusions through an arithmetic example, which provides more comprehensive theoretical support for insurance companies to design new BI insurance.

Third-Degree Price Discrimination in Two-Sided Markets

We investigate the welfare effects of third-degree price discrimination by a two-sided platform that enables interaction between buyers and sellers. Sellers are heterogeneous with respect to their per-interaction benefit, and, under price discrimination, the platform can condition its fee on sellers’ type. In a model with linear demand on each side, we show that price discrimination (i) increases participation on both sides, (ii) enhances total welfare, and (iii) may result in a strict Pareto improvement, with both seller types being better off than under uniform pricing. These results, which are in stark contrast to the traditional analysis of price discrimination, are driven by the existence of cross-group network effects. By improving the ability to monetize seller participation, price discrimination induces the platform to attract more buyers, which then increases seller participation. The Pareto improvement result means that even those sellers who pay a higher price under discrimination can be better off, because of the increased buyer participation. This paper was accepted by Joshua Gans, business strategy. Funding: A. de Cornière acknowledges funding from ANR [Grant ANR-17-EURE-0010] (Investissements d’Avenir program). Supplemental Material: The online appendix is available at https://doi.org/10.1287/mnsc.2023.02788 .

Unemployment Insurance in Macroeconomic Stabilization

Does the generosity of unemployment insurance (UI) have a role to play in macroeconomic stabilization? When inefficient fluctuations arise from nominal rigidities and constraints on monetary policy, I demonstrate that it does, owing to the interaction between UI and aggregate demand. From a positive perspective, a marginal increase in UI generosity affects output and employment through a redistribution effect on aggregate demand. From a normative perspective, two forces determine optimal generosity beyond the classic trade-off between insurance and incentives: an aggregate demand externality and an effect of low aggregate demand on the social cost of disincentives. The aggregate demand externality summarizes the welfare impact of the redistribution effect when the economy is slack; both are governed by the difference in marginal propensities to consume between the unemployed and employed. Quantitatively, a calibrated model with search frictions, incomplete markets, and a binding zero lower bound suggests that the 2008–13 UI benefit extensions in the U.S. had important stabilization effects through these channels. Compared to counterfactual benefit durations capped at 9 months in the calibrated model, the extensions to 22 months prevent a 2-5 percentage point rise in the unemployment rate and generate a strict Pareto improvement.

Research of two‐period insurance contract model with a low compensation period under adverse selection

The phenomenon of adverse selection caused by asymmetric information dominates the insurance market. In this paper, based on principal‐agent theory, we establish a two‐period dynamic insurance contract model with a low compensation period. This model introduces the tools of a low compensation period and the increase and decrease in the bonus to identify the risk types of policyholders. We prove that this model can achieve a strict Pareto improvement relative to the two‐period static insurance contract model with a low compensation period. Moreover, we also graphically analyze the conclusion, which can help insurance companies to design more comprehensive insurance contracts.

,,,Inequality and Equity in Bankruptcy Reorganization

Courts have developed a series of controversial doctrines that allow a debtor to depart from bankruptcy’s standard priority rules. In a recent decision, the Supreme Court signaled tolerance of one type of departure, the critical vendor payment, as long as it occurs early in the case and is what an economist would call a strict Pareto improvement: a payment that makes all creditors better off. This essay demonstrates that Pareto improvements appear in the stated tests governing other departures, including roll-ups and substantive consolidations. Some scholars, and a few courts, would apply much more permissive tests similar to economists’ Kaldor-Hicks standard and allow deviations as long as the winners gain more than the losers lose. Still other courts would do away with these doctrines entirely and allow departures only with the consent of the disfavored. Defending the judicial use of the Pareto standard in reorganizations, the essay further discusses some of the normative considerations in the choice between a Pareto standard, a Kaldor-Hicks standard, and an absolute prohibition.

Adaptation to climate change can support unilateral emission reductions

Policy advocates frequently call for unilateral action to promote international climate protection. It is still conventional wisdom that unilateral action does not pay off for individual countries due to free-riding incentives for other countries. Does this conclusion change if damage can be reduced by adaptation measures? This article considers adaptation as an explicit decision variable and frames unilateral action as Stackelberg game with two countries. The sequence of play is determined endogenously. We show that the Stackelberg leader reduces adaptation expenditures and emissions if the follower’s damage function has a specific convexity property where adaptation leads to strategic complements. Then, no country has an incentive to deviate from the sequence of play. Unilateral action in adaptation or in emissions leads to a strict Pareto improvement compared to the non-co-operative Nash solution. There are lower total emissions and less adaptation.

An insurance contract with a low compensation period under adverse selection

Adverse selection has a significant influence on trading efficiency in insurance markets. Inspired by the quality identification function of the probation period in the secondhand car market, an insurance contract with a low compensation period is designed. It is proved that the contract can distinguish the risk types of the policyholders to achieve a separating equilibrium. And it can make a strict Pareto improvement to the traditional partial insurance contract under certain conditions. Finally, an example is given to demonstrate the conclusions.

Reforming an asymmetric union: On the virtues of dual tier capital taxation

The tax competition for mobile capital, in particular the reluctance of small countries to agree on measures of tax coordination, has ongoing political and economic fallouts within Europe. We analyse the effects of introducing a two tier structure of capital taxation, where the asymmetric member states of a union choose a common, federal tax rate in the first stage, and then non-cooperatively set local tax rates in the second stage. We show that this mechanism effectively reduces competition for mobile capital between the members of the union. Moreover, it distributes the gains across the heterogeneous states in a way that yields a strict Pareto improvement over a one tier system of purely local tax choices. We also discuss the effects of diverging capital endowments within the union and capital flows to third countries.

Policy-Making and the Adaptability of Informal Institutions

This article discusses several of the insights generated by a theory of the formation of relationships between heterogeneously risk-averse individuals who lack access to formal insurance. An example illustrates the policy relevance of the theory, and demonstrates a relationship between the emergence of entrepreneurship in developing economies and higher income inequality. Reducing aggregate risk is a strict Pareto improvement if relationships in the status quo are assumed to remain constant, but is shown to be particularly harmful for the most risk-averse individuals and to exacerbate inequality when the endogenous network response is taken into account: the least risk-averse individuals abandon their roles as informal insurers in favor of entrepreneurial partnerships.

A Pareto-improving Minimum Wage

This paper shows that a graduated minimum wage, in contrast to a constant minimum wage, can provide a strict Pareto improvement over what can be achieved with an optimal income tax. The reason is that a graduated minimum wage requires high-productivity workers to work more to earn the same income as low-productivity workers, which makes it more difficult for the former to mimic the latter. In effect, a graduated minimum wage allows the low-productivity workers to benefit from second-degree price discrimination, which increases their income.

A Pareto-Improving Minimum Wage

This paper shows that a graduated minimum wage, in contrast to a constant minimum wage, can provide a strict Pareto improvement over what can be achieved with an optimal income tax. The reason is that a graduated minimum wage requires high-productivity workers to work more to earn the same income as low-productivity workers, which makes it more difficult for the former to mimic the latter. In effect, a graduated minimum wage allows the low-productivity workers to benefit from second-degree price discrimination which increases their income.

Pareto-improving tariff-tax reforms under imperfect competition

Constructing a duopoly model with non-constant marginal costs and a strict Pareto criterion, this paper examines welfare effects of world-price-fixing tariff reductions accompanied by adjustments of a domestic tax. If a destination-based consumption tax is used, this reform achieves a strict Pareto improvement under sufficiently decreasing marginal costs. If, in contrast, an origin-based production tax is employed, a strict Pareto improvement holds whether marginal cost is decreasing or not. Thus, we can conclude that tariff-tax reforms that improve the world welfare and are irrelevant of tax bases are possible if the targeted industry exhibits sufficiently decreasing marginal costs.

Welfare-improving ambiguity in insurance markets with asymmetric information

We consider a model of competitive insurance markets involving both asymmetric information and ambiguity about the accident probability. We show that there can exist a full-insurance pooling equilibrium. We also present an example where an increase in ambiguity leads to a strict Pareto improvement. Higher ambiguity relaxes high-risks' incentive compatibility constraint and allows low risks to buy more insurance. Higher ambiguity also deteriorates low risks' expected utility from holding an uncertain prospect. If the former effect dominates, the expected utility of low risks increases and given that high risks' utility remains unaffected, the increase in ambiguity implies a strict Pareto improvement.

Welfare-Improving Ambiguity

We consider a model of competitive insurance markets involving both asymmetric information and ambiguity about the accident probability. We show that there can exist a full-insurance pooling equilibrium. We also present an example where an increase in ambiguity leads to a strict Pareto improvement. Higher ambiguity relaxes the high-risks’ incentive compatibility constraint and allows low risks to buy more insurance. Higher ambiguity also deteriorates the low risks’ expected utility from holding an uncertain prospect. If the former effect dominates, the expected utility of low risks increases and given that the high risks’ utility remains unaffected, the increase in ambiguity implies a strict Pareto improvement.

An auction market for journal articles

We recommend that an auction market replace the current system for submitting academic papers and show a strict Pareto-improvement in equilibrium. Besides the benefit of speed, this mechanism increases the average quality of articles and journals and rewards editors and referees for their effort. The “academic dollar” proceeds from papers sold at auction go to authors, editors and referees of cited articles. This nonpecuniary income indicates the academic impact of an article—facilitating decisions on tenure and promotion. This auction market does not require more work of editors.

Inefficient Centralization of Imperfect Complements

If local public goods exhibit spillovers and regions are sufficiently symmetric, decentralization implies under provision, whereas cooperative centralization is associated with strict Pareto-improvement. This classic inference rests on two assumptions: local politicians are delegated sincerely and never provide voluntary transfers to the other regions. We abandon these assumptions in a setup of two symmetric regions with imperfect complementarity between local public goods. For this particular aggregation, non-cooperative decentralization can achieve the social optimum, whereas cooperative centralization cannot.

On the Welfare Improving Trade in Marginal Tax Rates

In this paper we extend the dimensionality of the standard income taxation problem. Specifically, we allow agents to purchase at a price, from the government, discounts on their marginal tax rates. Consequently agents have two decision variables: the level of income they choose to earn and the magnitude of discount they want to purchase at a given price. By rationally choosing to purchase discounts agents face lower effective marginal tax rates, which enhances efficiency. At the same time agents pay a price for the discounts, which can compensate for a shortfall in revenue resulting from lower e?ective marginal tax rates. We show, in the case of the CRRA utility function, that for any tax function it is always possible to construct the corresponding discount price function that leads to a strict Pareto improvement through trade in discounts and that ensures that revenue collected is unaffected when trade in discounts is permitted. In addition, we show that a fat tax or a piece-wise linear tax function are never optimal in the Mirrlees's sense. Similarly, we argue that trade in discounts can lead to a Pareto improvement over the allocation induced by any tax function, including Mirrlees's solutions, that has an existing inverse and is differentiable. We also show that the standard asymptotic result of zero marginal tax rate at the top of income distribution can be extended to an open set. It is shown in the dynamic context that no tax function can be optimal unless it is conditioned on the entire income history.

On cheating, doping and whistleblowing

We study the role of whistleblowing in the following inspection game. Two agents who compete for a prize can either behave legally or illegally. After the competition, a controller investigates the agents' behavior. This inspection game has a unique Bayesian equilibrium in mixed strategies. We then add a whistleblowing stage, where the controller asks the loser to blow the whistle. We show that our whistleblowing mechanism reduces the frequencies of cheating, is less costly in terms of test frequencies, and leads to a strict Pareto-improvement if punishments for cheating are sufficiently large.

Selling to the “Newsvendor” with a forecast update: Analysis of a dual purchase contract

We consider a supply chain in which a manufacturer sells to a procure-to-stock retailer facing a newsvendor problem with a forecast update. Under a wholesale price contract, the retailer waits as long as she can and optimally places her order after observing the forecast update. We show that the retailer’s wait-and-decide strategy, induced by the wholesale price contract, hinders the manufacturer’s ability to (1) set the wholesale price and maximize his profit, (2) hedge against excess inventory risk, and (3) reduce his profit uncertainty. To mitigate the adverse effect of wholesale price contract, we propose the dual purchase contract, through which the manufacturer provides a discount for orders placed before the forecast update. We characterize how and when a dual purchase contract creates strict Pareto improvement over a wholesale price contract. To do so, we establish the retailer’s optimal ordering policy and the manufacturer’s optimal pricing and production policies. We show how the dual purchase contract reduces profit variability and how it can be used as a risk hedging tool for a risk averse manufacturer. Through a numerical study, we provide additional managerial insights and show, for example, that market uncertainty is a key factor that defines when the dual purchase contract provides strict Pareto improvement over the wholesale price contract.

An Auction Market for Journal Articles

We recommend that an auction market replace the current system for submitting papers and show a strict Pareto-improvement in equilibrium. Besides the benefit of speed, this mechanism increases the average quality of articles and journals and rewards editors and referees for their effort. The academic dollar proceeds from papers sold at auction go to authors, editors and referees of cited articles. This nonpecuniary income indicates the impact of an article - facilitating decisions on tenure and promotion. This auction market does not require more work of editors.