Knowledge that Transforms

The author discusses the U.S. monetary policy proposed and developed by John B. Taylor (1993) within the context of economic theory and economic welfare.

Market Structure and Racial Earnings: Evidence from Job-Changers by Jacqueline Agesa, Richard U. Agesa and Gary A. Hoover. Published in volume 91, issue 2, pages 169-173 of American Economic Review, May 2001

There exists by now a burgeoning literature concerned with the consequences of a fixed cost of price adjustment. Due to this cost, a monopolistic firm does not necessarily adjust its price even though the current price deviates from the price that would maximize the firm's current profit. As a result, the production generally differs from what it would be in the absence of a menu cost, with the effect of inflation on the average output and welfare under monopolistic competition being ambiguous and depending in a complicated way on the profit and demand functions. 1 However, one strong result holds unambiguously for all profit and demand functions: at low inflation rates, the average output and welfare are above their levels at full price stability where firms charge the static monopoly price.2 The driving force is that discounting makes a firm more concerned with its real profits earlier in a period with a constant nominal price than with its real profits later in the period. In fact, as the inflation rate approaches zero, the firm's initial real price converges to the profit-maximizing real price, while the terminal real price converges to a smaller real price. At low inflation rates, therefore, a firm's price is most of the time below the price that would maximize the current profit. Since output and welfare under monopolistic competition are inversely related to price, average output and welfare are higher than under full price stability. The inevitable conclusion is that the economy benefits from a little bit of inflation. A critical assumption underlying this result is that firms can continuously adjust their production to satisfy demand. So while the menu-cost literature explicitly assumes that there is a small fixed cost incurred at each price adjustment, it also implicitly assumes that it is costless to continuously adjust the quantity of output.3 This is, however, a questionable assumption. There is some empirical evidence indicating the existence of a cost of quantity adjustment, part of which is fixed in that it does not depend on the size of the adjustment.4 The cost of quantity adjustment stems from the need to rearrange and reorganize the factor inputs for the new level of production and includes managerial time and effort. A fixed cost of quantity adjustment rules out any continuous adjustment of the production to satisfy the increasing demand that results from a decreasing real price within a period with a constant nominal price. Under the reasonable assumption that the menu cost does not exceed the fixed cost of quantity adjustment,5 in an inflationary environment a firm chooses to adjust its nomi-

The assumption that nominal price adjustment is costly for firms (there are "menu costs") has generated a stream of important theoretical papers over the last decade or so. 1 In so far as this literature generates asymmetric adjustments, it provides a theoretical underpinning for the (old)Keynesian assumption that nominal prices are more flexible upward than downward. 2Yet, the empirical evidence, while confirming that asymmetri es exist, does not indicate the dominance of any particular form of asymmetry (see Dennis W. Carlton, 1986; Alan S. Blinder, 1991).In this paper we argue that the gap between theory and practice may be the result of the focus of menucost models on specific forms of market structure.Existing menu -cost models are based on the assumption of relatively uncompetitive market structures -monopoly, oligopoly, or monopolistic competition with a fixed number of firms.We widen the scope of the analysis by examining what we call a quasi-competitive industry and demonstrate that it displays a pattern of adjustment quite different from that found in other models.The Keynesian asymmetry is reversed, with nominal price being more flexible downward than upward. 3 We suggest therefore that a relationship exists between market structure and the pattern of nominal price adjustment.Since there is presumably a variety of market structures, this may help explain the inconclusive empirical evidence.We model the most competitive market configuration compatible with menu costs:Bertrand oligopoly in a dynamic setting with free entry.It is assumed that (a) an incumbent in one period can continue to sell at its existing nominal price in the next period without incurring any additional menu cost, whereas an entrant would have to incur a menu cost; and (b) among the firms willing to sell at the lowest price in any given period, one is chosen randomly to sell the

The connection between obtaining higher paying jobs and undertaking some seemingly irrelevant activity is interpreted as “social culture.” In the context of a society trying to adopt a new technology, I show that by allowing the firms to give preferential treatment to workers based on some “cultural activity,” the society can partially overcome an informational free-riding problem. Therefore, social culture may affect the economic performance by altering the effective production technology of the economy.

Do Explicit Warnings Eliminate the Hypothetical Bias in Elicitation Procedures? Evidence from Field Auctions for Sportscards by John A. List. Published in volume 91, issue 5, pages 1498-1507 of American Economic Review, December 2001

Comparing Apples to Oranges: Productivity Convergence and Measurement across Industries and Countries: Reply by Andrew B. Bernard and Charles I. Jones. Published in volume 91, issue 4, pages 1168-1169 of American Economic Review, September 2001

Growing Up in the Projects: The Economic Lives of a Cohort of Men Who Came of Age in Chicago Public Housing by Steven D. Levitt and Sudhir Alladi Venkatesh. Published in volume 91, issue 2, pages 79-84 of American Economic Review, May 2001

Major technological, regulatory, and institutional changes have made finance more widely available in recent years. The ability of institutions to price a variety of exotic instruments, and to assess and spread risks, has increased. More data on potential borrowers is now available, and it is also more timely. Improvements in accounting disclosure have resulted in greater borrower transparency. Deregulation has resulted in greater competition and better prices in markets. Finally, regulatory barriers protecting the turf of different kinds of institutions have come down, resulting in the emergence of new institutional forms. These changes amount to a bona fide financial revolution. In this article, we focus on the impact the revolution has had on the way firms are (or should be) organized and managed, and on the policy consequences. To do this, we first need to understand what firms are and what drives their organizational structure. A caveat is in order at the outset. Finance is not the only force transforming the nature of firms in the last two decades; deregulation and technological change have also played big roles. These have been explored elsewhere (see e.g., Rajan and Zingales, 2000); hence, our focus. I. Critical Resource Theory

In his path-breaking 1937 article, Ronald Coase first identified the determinants of a firm's scope as an important research question. Although Coase's question initially attracted little attention, it has emerged over the last 25 years as a central issue in industrial organization. Much of the literature on firm scope since Coase uses the transaction-cost economics approach (henceforth, the TCE) pioneered by Oliver Williamson (1975, 1979, 1985) and Benjamin Klein et al. (1978). The TCE starts with the assumption that market transactions are plagued by incomplete contracts and the development of lock-in among trading partners. Lock-in leads the value of the relationship to exceed the value of the trading partners' outside alternatives creating what Klein et al. called quasi-rents. Contractual incompleteness gives contracting parties the ability to engage in opportunistic behavior to increase their share of these quasi-rents, leading to efficiency losses in market transactions. Internal procurement, on the other hand, involves its own inefficiencies, most notably the costs of bureaucracy and lowpowered incentives. According to the TCE, the optimal organizational form is found by comparing the efficiencies of these distinct transactional modes. Its primary prediction is that, as market transactions become characterized by increasing levels of quasi-rents and incompleteness in contracts, the likelihood of integration should increase. More recently, a great deal of attention has focused on an alternative theory of firm scope, the property-rights theory (henceforth, the PRT), pioneered by Sanford Grossman and Oliver Hart (1986) and Hart and John Moore (1990) (see also Hart, 1995). Like the TCE, the PRT starts with the assumption that contracts are incomplete and that lock-in often develops among trading partners. It then focuses on how ownership of physical assets, which confers residual rights of control over the assets, alters the efficiency of trading relations. In the process of doing so, the PRT produces a theory that differs from the TCE in three ways. The first is methodological rather than substantive: the PRT is substantially more formal than the (largely verbal) TCE. Second, the PRT focuses on distortions in ex ante investments, in contrast to the ex post haggling costs that are a major focus of the TCE.1 Third, the PRT assumes that efficiency losses are of the same nature in all ownership structures. That is, ownership of physical assets affects the parties' abilities to engage in opportunistic behavior not only in market transactions, but also within the firm. A very large empirical literature exists lending support to the TCE (for one survey, see Howard A. Shelanski and Peter G. Klein [1995]). In a typical study, some measure of lock-in, such as the specificity of the product procured or investments made, is related to the choice of whether to integrate. The strong association that this literature has found between specificity and integration has made the TCE