Knowledge that Transforms

The problem of eliciting honest preferences from individuals who must be assigned to a set of positions is considered. Individuals know that they will be charged for the positions to which they are assigned. A set of prices that provide no incentive for the individual to misrepresent his preferences is suggested. It is shown that these prices constitute an element of the optimal solution to the dual of a linear programming assignment problem. Both the optimal allocation and the prices to be charged can be derived by solving two linear programming problems once preferences have been elicited. The procedure can usefully be viewed as a simulation of a competitive market under conditions where such a market cannot be expected to function well. It results in an efficient allocation where all resources are valued at their opportunity costs and "consumer surplus" is maximized; its outcome thus has the desirable properties of competitive market equilibria.

The observed practice of contracting for labor services in advance introduces stickiness or friction into the economic system. In the presence of monetary and real stochastic disturbances the stability of the levels of employment and output hinges on the nature of the wage contracts. In this paper we demonstrate the existence of optimal indexation schemes that are capable of eliminating the aforementioned friction by duplicating the equilibrium that would obtain if labor services were contracted for after the stochastic disturbances were realized.

A long tradition in the development literature has been to associate the aggregate savings rate with the dependency ratio, the ratio of dependent children to adults. In this paper I formalize the relationship by developing a life-cycle model in which offspring are assets from the viewpoint of their parents. The model is used to help explain the increase in nineteenth-century U.S. savings rates. I find that between 1830 and 1900 about one-quarter of the 6-percentage-point rise in the savings rate can be attributed to a decline in the dependency rate.

A general equilibrium model of optimal employment contracts is developed where firms have better information about labor's marginal product than workers. It is optimal for the wage to be tied to the level of employment, to prevent the firm from falsely stating that the marginal product is low and cutting the wage. It is shown that an observed aggregate shock that leads to an interindustry shift in labor demand and that would have no effect on total employment under symmetric information leads to a reduction in employment when firms and workers have asymmetric information.

Tournaments, reward structures based on rank order, are compared with individual contracts in a model with one risk-neutral principal and many risk-averse agents. Each agent's output is a stochastic function of his effort level plus an additive shock term that is common to all the agents. The principal observes only the output levels of the agents. It is shown that, in the absence of a common shock, using optimal independent contracts dominates using the optimal tournament. Conversely, if the distribution of the common shock is sufficiently diffuse, using the optimal tournament dominates using optimal independent contracts. Finally, it is shown that for a sufficiently large number of agents, a principal who cannot observe the common shock but uses the optimal tournament does as well as one who can observe the shock and uses independent contracts.

The public good aspect of information is used to account for periods in which the aggregate level of trade is low. It is shown that abstention from trade may occur when the uncertainty with respect to the market-clearing price (there is no auctioneer) gets large relative to the cost of getting information about it and relative to the cost of postponing transactions. In this case, all agents are aware of bilateral Pareto-improving trading opportunities, but these opportunities are not exploited.

This paper extends Stigler and Peltzman's approach to regulation by incorporating a legislature. The model yields comparative statics results and hence testable implications. The paper then tests between two opposing approaches about regulatory agency behavior. The first assumes agencies operate independently of the legislature and hence exercise discretion; the second assumes that Congress controls agency decisions. The recent behavior of the Federal Trade Commission provides the empirical setting. Substantial evidence is found for the specific predictions of the model, including the hypothesis of systematic congressional influence over FTC decisions.

This paper develops a model of quality determination where the usual competitive equilibrium conditions hold. The explicit form of quality considered is the wait required to obtain the product. The analysis, however, is much more general, being valid for products that have a characteristic, z, such that (1) demand is a function of price and a measure defined on z, (2) costs are a function of output and the measure on z, and (3) z is a function of output and capacity. Expected profit-maximizing firms, in equilibrium, look like monopolistic competitors. Once constant quality is imposed, however, the perfect competitive results obtain.

Can extrinsic uncertainty ("animal spirits," "market psychology," "sunspots,"...) play a significant role in rational expectations equilibrium models? We establish that extrinsic uncertainty cannot matter in the static Arrow-Debreu economy with complete markets. But we also establish that extrinsic uncertainty can matter in the overlapping-generations economy with complete markets but where market participation is limited to those consumers alive when the markets are open. Equilibrium allocations in which extrinsic uncertainty plays no role are Pareto optimal in the traditional sense. Equilibrium allocations in which extrinsic uncertainty does play a role are Pareto optimal in a (weaker) sense which is appropriate to dynamic analysis.