Welfare Properties Research Articles

Inefficient Credit Booms

This paper studies the welfare properties of competitive equilibria in an economy with financial frictions hit by aggregate shocks. In particular, it shows that competitive financial contracts can result in excessive borrowing ex ante and excessive volatility ex post. Even though from a first-best perspective the equilibrium always displays under-borrowing, from a second-best point of view excessive borrowing can arise. The inefficiency is due to the combination of limited commitment in financial contracts and the fact that asset prices are determined in a spot market. This generates a pecuniary externality that is not internalized in private contracts. The model provides a framework to evaluate preventive policies, which can be used during a credit boom to reduce the expected costs of a financial crisis.

Outside versus Inside Bonds

When agents are liquidity constrained, two options exist — borrow or sell assets. We compare the welfare properties of these options in two economies: in one, agents can borrow (issue inside bonds) and in the other they can sell government bonds (outside bonds). All transactions are voluntary, implying no taxation or forced redemption of private debt. We show that any allocation in the economy with inside bonds can be replicated in the economy with outside bonds and that the converse is not true. Moreover, under best policies, the allocation with outside bonds strictly Pareto dominates the allocation with inside bonds.

A welfare simulation of mixed-member electoral systems

This paper considers welfare properties of mixed-member electoral systems. In a mixed system, voters may elect high-quality district representatives without excessive campaign fundraising. Simulation results reveal that the optimally mixed electoral system can be welfare-enhancing, but a poorly targeted electoral reform can do worse than a PR system or plurality rule.

Constrained inefficiency in GEI: A geometric argument

In this paper we use global analysis to study the welfare properties of general equilibrium economies with incomplete markets (GEI). Our main result is to show that constrained Pareto optimal equilibria are contained in a submanifold of the equilibrium set. This result is explicitly derived for economies with real assets and fixed aggregate resources, of which real numéraire assets are a special case. As a by product of our analysis, we propose an original global parametrization of the equilibrium set that generalizes to incomplete markets the classical one, first, proposed by Lange [Lange, O., 1942. The foundations of welfare economics. Econometrica 10, 215–228].

Quality Risk Aversion, Conjectures, and New Product Diffusion

In this paper we provide a generalization of the standard models of the diffusion of a new product. Consumers are heterogeneous and risk averse, and the firm is uncertain about the demand curve: both learn from past observations. The attitude towards risk has important effects with regard to the diffusion pattern. In our model, downward-biased signals to consumers can prevent the success of the product, even if its objective quality is high: a lock-in result. We show in addition that the standard logistic pattern can be derived from the model. Finally, we discuss the asymptotic behavior of the learning dynamics, with regard to the multiplicity and the stability of equilibria, and to their welfare properties.

A note on national income in a dynamic economy

We review the properties of the static measure of changes in economic welfare, national income, in a dynamic economy. It is possible to establish attractive welfare properties by rather simple arguments, and this can be estimated from current data. Its welfare properties are preferable to those of net national product and comparable to those of the state valuation function.

General equilibrium with nonconvexities and money

In a general-equilibrium economy with nonconvexities, there are sunspot equilibria with good welfare properties; sunspots can ameliorate the effects of the nonconvexities. For these economies, we show that agents act as if they have quasi-linear utility functions. We use this result to construct a new model of monetary exchange along the lines of Lagos and Wright, where trade occurs in both centralized and decentralized markets, but instead of quasi-linear preferences we assume general preferences but with indivisible labor. This suggests that modern monetary theory is more robust than one might have thought. It also constitutes progress on the classic problem of integrating monetary economics and general-equilibrium theory.

Welfare properties of spatial competition with location-dependent costs

We analyze a two-firm spatial competition model in which firms must transport raw materials from a raw material site to their locations in order to produce. The model has two equilibrium configurations: (i) a symmetric one in which firms locates equidistantly from the raw material site, and (ii) an asymmetric one in which one firm locates at the raw material site and the other locates distantly from it. We show that these two configurations are possible as multiple equilibria, that the asymmetric equilibrium is more efficient than the symmetric one, and that the social welfare first falls then rises as transport costs decline.

Content and advertising in the media: Pay-tv versus free-to-air

We compare the advertising intensity and content of programming in a market with competing media platforms. With pay-tv, media platforms have two sources of revenues, advertising revenues and revenues from viewers. With free-to-air, media platforms receive all revenues from advertising. We show that if viewers strongly dislike advertising, the advertising intensity is greater under free-to-air television. We also show that free-to-air television tends to provide less differentiated content whereas pay-tv stations always maximally differentiate their content. In addition, we compare the welfare properties of the two different schemes.

THE ROLE OF EXCLUSIVE CONTRACTS IN FACILITATING MARKET TRANSACTIONS*

We examine the relationship between market conditions and the adoption of exclusive contracts. In particular, we develop a matching model in which agents may decide to adopt exclusive contracts to reduce bilateral bargaining inefficiencies in the presence of private information. We show that it is optimal for agents to adopt exclusive contracts in thin markets but not in thick markets and that for intermediate levels of market thickness strategic complementarities lead to multiple equilibria. We study the welfare properties of market equilibria and discuss under what circumstances courts should enforce exclusive contracts.

Foreign Money Shocks and the Welfare Performance of Alternative Monetary Policy Regimes*

AbstractThe welfare properties of monetary policy regimes for a country subject to foreign money shocks are examined in a two‐country sticky‐price model. Money targeting is found to be welfare superior to a fixed exchange rate when the expenditure switching effect of exchange rate changes is relatively weak, but a fixed rate is superior when the expenditure switching effect is strong. However, price targeting is superior to both these regimes for all values of the expenditure switching effect. A welfare‐maximising monetary rule yields lower output and exchange rate volatility than price targeting for a wide range of parameter values.

Competition Between Firms that Bundle Information Goods

Information goods are characterized by high fixed (first-copy) costs, but very low costs for the production of additional copies. Marginal costs of electronically-delivered information goods have been further reduced by the remarkable recent decline in computing and digital communication costs. Most previous research focuses on how a monopolist would perform (and the proper regulation to impose) in such an environment. Achieving dynamic efficiency is difficult because pricing at marginal cost (which is statically efficient) eliminates the incentive to invest in the creation of new content. Recently, the strategy of bundling numerous goods together has been explored in greater detail. Bundling may achieve static efficiency since individuals will face a zero cost on the margin for each item consumed. Yet, dynamic efficiency can be maintained because the producer is able to recover investment costs through bundle sales. This paper analyzes the profitability and welfare properties of bundling in a multi-firm setting. This allows us to explore how incumbents and entrants interact when each firm is selling numerous competing products. Our fundamental conclusion is that even adding only a single firm to this industry with substantial fixed costs and negligible marginal costs will result in much lower prices for consumers, much higher social welfare, and only a moderate reduction in firms' profits regardless of the pricing schemes employed. This outcome is somewhat surprising given that in a standard static two-good Bertrand model, a duopoly would lead to a price war which eliminates the incentive to invest in new content (or to enter the industry in the first place). Although the firms are producing a priori identical items, consumers know that their valuations for the particular items will vary ex post. Thus, no price reduction by one firm can completely eliminate the demand faced by other firms. Although there remains an incentive to invest in new product creation, this incentive is lower than a monopolist would have. As a result, in a dynamic version of this model, the welfare superiority of the duopoly becomes dampened (but not eliminated). Finally, when firms are allowed to sell items both as a bundle and individually, we find that most revenue will be obtained from bundle sales. These results indicate that bundling will persist in a multi-firm setting and suggest that only firms of substantial size will be able to survive in such a market.

Bidding for money

We analyze monetary exchange in a model that allows for directed search and multilateral matches. We consider environments with divisible goods and indivisible money, and compare the results with those in models that use random matching and bilateral bargaining. Two different pricing mechanisms are used: ex ante price posting, and ex post bidding (auctions). Also, we consider settings both with and without lotteries. We find that the model generates very simple and intuitive equilibrium allocations that are similar to those with random matching and bargaining, but with different comparative static and welfare properties.

Ordered bargaining

When buyers choose the order in which they bargain with suppliers of known characteristics, prices are determined jointly by bargaining power and competitive intensity (the outside option to bargain with rival suppliers). Bargaining power becomes less important to the outcome as competition intensifies; prices fall to marginal cost in the limit. With positive visit costs and weak competition, some buyer power is necessary for trade. Incomplete buyer power may lead to inefficient choice of bargaining order. The robustness of ordered bargaining to the possibility of price posting and auctions, and welfare properties of these alternative pricing institutions, are also explored.

Constrained Inefficiency in Gei: a Geometric Argument

In this paper we use global analysis to study the welfare properties of general equilibrium economies with incomplete markets (GEI). Our main result is to show that constrained Pareto optimal equilibria are contained in a submanifold of the equilibrium set. This result is explicitly derived for economies with real assets and fixed aggregate resources, of which real numeraire assets are a special case. As a by product of our analysis, we propose an original global parametrization of the equilibrium set that generalizes to incomplete markets the classical one, first, proposed by Lange (1942).

On informative advertising and product differentiation

We study informative advertising within a random utility, non-localized competition model of product differentiation. Quasi-concavity of profits may fail, as each firm may prefer to deviate to a high price, targeting consumers who only become informed about its own product. When a symmetric equilibrium exists, it is unique. Increasing the number of firms may increase or decrease the equilibrium price. Advertising tends to be suboptimal when product differentiation is low and excessive otherwise. We also revisit Grossman and Shapiro [Grossman, G., Shapiro, S., 1984. Informative advertising with differentiated products. Review of Economic Studies 51, 63–81], focusing on similarities in constructing a symmetric equilibrium in the two models, but also illustrating differences in their welfare properties.

Complementary versus semi-complementary airline partnerships

As low-cost airlines or carriers excluded from international markets by regulation may seek to expand internationally in an indirect way through code-sharing agreements, they can choose partner airlines from among domestic or international carriers. The former case results in a semi-complementary partnership, while in the latter a classic complementary alliance is formed. This paper compares welfare properties of the two types of partnerships under economies of traffic density. Semi-complementary partnerships yield higher total welfare (but not necessarily lower prices) when economies of traffic density are strong, demand is more price-sensitive, or where a carrier feeding domestic traffic to international routes is a lower cost one.

Indirect Costs and Cost-Effectiveness Analysis

This article examines the methodological implications of the societal perspective in cost-effectiveness analyses in which the costs of health-care interventions are defined as the sums of direct and indirect costs. In the model of cost-effectiveness analysis in which the planner distributes patients among many treatments for many illnesses, the definition requires that total indirect costs be constrained, and the article proposes an iterative computational procedure for choosing a constraint under the assumption that the planner maintains a target trade-off rate between losses of health benefits and reductions in indirect costs. In the more common model in which the planner decides which of two treatments for one illness to provide to patients, the adoption of a societal perspective introduces ambiguities into the welfare properties of the decision rule, and in general the conclusion that a treatment is cost-effective is valid only if switching or assigning patients to the cost-effective treatment does not increase the planner's total direct costs.

Resale price maintenance under asymmetric information

We study Resale Price Maintenance (RPM) and quantity fixing arrangements (QF) in a framework with successive monopolies under both adverse selection and moral hazard. The analysis compares the private and the welfare properties of both contractual modes. Under asymmetric information, both kinds of vertical contracts entail a double marginalization driven by the information rents distributed to a privately informed downstream retailer. This forces the upstream producer to sell above his marginal costs. The upstream producer always prefers RPM to QF, but the impact of RPM on consumers' surplus is ambiguous. Whenever RPM is the preferred contracting mode for the vertical structure from an ex ante viewpoint, it also raises consumers' surplus, thereby producing a Pareto improvement relative to QF contracts.

An equilibrium voting model of federal standards with externalities

This paper proposes a framework for studying policy making in a federal system in the presence of spillover externalities. Local jurisdictions choose local policies by majority rule subject to standards that are set by majority rule at the federal level. We characterize the induced preferences of voters for federal policies, prove existence of local majority rule equilibrium, provide an example of non-existence of global majority rule equilibrium, and explore the welfare properties of federal standards in the presence of spillovers.