Knowledge that Transforms

Many economic situations with asymmetric information can be modeled as signaling games. Even simple signaling games can have sequential equilibria that are considered unintuitive. For example, in a wellknown model due to Michael Spence (1973), workers with good information about their own ability levels have to decide whether to obtain additional education or not. An employer, knowing that education is more costly for low-ability workers, observes the education signal, but not the worker's ability, prior to deciding on a wage offer. As shown below, it is possible to construct examples in which all types of workers decide against the educational investment because the employer will interpret education as a signal of low ability, even though the signal is not less costly for low-ability workers. Despite the unintuitive nature of these out-of-equilibrium beliefs, this equilibrium outcome survives the tests imposed by all of the commonly used, strengthened versions of the Nash concept. In particular, this outcome is a sequential equilibrium in the sense of David M. Kreps and Robert Wilson (1982); it satisfies a backwards-induction rationality requirement that decisions be optimal from any nonterminal stage until the end of the game, given the equilibrium beliefs at that stage. Despite the fact that unintuitive outcomes can pass the test imposed by a sequential equilibrium, there is no consensus on exactly how this equilibrium concept should be strengthened or refined. The recent debate centers on refinements that place more restrictions on players' beliefs about what would happen off the equilibrium path. Several refinements have been proposed, each of which is motivated by specific games in which a weaker refinement permits unreasonable equilibria. For example, In-Koo Cho and Kreps (1987) discuss their intuitive criterion, which is based on a dominance notion that they call equilibrium dominance. They also discuss a number of stronger refinements, including strategic stability (Elon Kohlberg and JeanFrancois Mertens, 1986) and divinity (Jeffrey Banks and Joel Sobel, 1987).1 We are particularly interested in equilibrium dominance, since it is widely discussed and since it is implied by stronger refinements. The arguments about which refinement is appropriate are typically based on subjective opinions about how reasonable individuals would behave. There is an apparent need for empirical work that directly tests the validity of these arguments; such work could guide the theoretical debate toward alternative refinements. Although game theory is sometimes used as a normative theory about how rational agents ought to behave, the theory is also widely applied in

This paper investigates the sources and methods used to construct the aggregate data on consumer spending in the United States, searching especially for imperfections that may have implications for the outcome of empirical work. The paper identifies two such imperfections: sampling error and compositional error. It then presents several examples intended to illustrate that these imperfections may be empirically important and that appropriate remedies for them often can be devised. The paper concludes by suggesting some guidelines of empirical practice.

The authors establish a framework wherein agents make expectation-revision decisions subject to a specified calculation technology and preferences over forecast errors. The technology endows agents with correctly specified economic models, but the cost of expectation calculation using these models leads to gradual and incomplete adjustment to long-run rational-expectation equilibrium. The rational-expectations hypothesis emerges as a special case of the equilibrium paths obtained in the authors' framework. In a natural-rate model of monetary policy, calculation technology gives rise to long-run nonneutrality and hysteresis effects, and incomplete adjustment of forecast rules causes output fluctuations to be amplified.

The authors propose and implement a new test of the dividend signaling hypothesis. Dividend signaling models generally imply that an increase in dividend taxation should increase the share price response per dollar of dividends (or 'bang-for-the-buck'). Many other dividend-preference theories have the opposite implication. An analysis of recent variations in tax policy reveals a strong positive relation between dividend tax rates and the bang-for-the-buck. Additional evidence on the relation between the bang-for-the-buck and other variables that are related to the marginal cost of paying dividends provides further support for dividend signaling.

Economic theory been under severe attack in recent years. The source of this attack been the observation of apparently robust behavioral in decisions that experimental subjects make in controlled environments. The implication of these observations drawn by some is that many of the fundamental tenets of economic theory are systematically misleading as a descriptive model of human behavior. Many alternative models of individual and group behavior have been proposed which can account for some or all of the apparent anomalies. In the Theory and Misbehavior of FirstPrice Auctions (Harrison, 1989), I argued that the effort to extend or generalize received auction theory as a response to such was misdirected. Specifically, I argued that the observed in the experiments in question may simply reflect the failure of the experiment to meet widely accepted sufficient conditions for a valid controlled experiment proposed by Vernon Smith (1982 pp. 930-9). The result of this failure is simply that the opportunity cost of in these experiments is, by any reasonable standard, minuscule. Observed anomalies may then not be at all: they reflect theoretically consistent behavior under conditions where misbehavior is virtually costless. My critique is quite general in going well beyond auction theory and sealed-bid experiments. Perhaps for this reason there is some truth in the assessment of John D. Hey (1991 p. 195) that it has stirred the passions of the experimental community throughout America. The sad corollary of that assessment, however, is that experimentalists must be a pretty dull lot if such modest concerns as mine stir their passions. Section I restates the payoff-dominance critique in general terms to introduce the nonexperimentalist to the main issues. To address some of the issues raised by my critics, Section II contains a detailed numerical example of an important experimental procedure for eliciting the certainty-equivalent of any lottery that uses the G. M. Becker et al. (1964) procedure. In Section III, the generality of the problem is briefly catalogued, so as to emphasize that this is a debate over much broader methodological matters than sealed-bid auction experiments. Section IV addresses directly some of the specific comments of my critics. Section V identifies a number of qualifications to my critique of existing experimental practice.

This paper compares risk-taking of insured.and uninsured thrifts operating under strict and less-strict regulatory regimes during the 1930's. Analysis of balance-sheet data indicates that while newly insured thrifts undertook less risk than their uninsured counterparts, possibly because of screening by deposit-insurance authorities, moral hazard emerged gradually. Insured institutions operating under relatively permissive regulatory regimes were more prone to undertake risky lending activities than their more tightly regulated counterparts, possibly because of screening by deposit-insurance authorities, moral hazard emerged gradually. Insured institutions operating under relatively premissive regulatory regimes were more prone to undertake risky lending activities than their more tightly regulated counterparts. Given the current system of deposit insurance, the results suggest that effective regulation and supervision will play a key role in maintaining thrift stability in the 1990s.

An important characteristic of many environmental programs is that their benefits extend far into the future. The primary purpose of cleanups at hazardous-waste disposal sites, for example, is often to prevent the contamination of groundwater that could pose risks to future residents at these sites. Such cleanups typically involve considerable capital and other costs, which are incurred at the front end of the project, and yield a stream of health benefits, often in the form of cancer cases avoided, that may not be recognized for many years. This would not pose unusual problems for program evaluation if everyone were comfortable with the assignment of dollar values to these reductions in future risk (see Cropper and Portney, 1990). However, regulatory agencies are sometimes reluctant to make such monetary valuations, preferring instead to evaluate programs on a cost-per-life-saved (CPLS) basis (Office of Management and Budget, 1991). This raises an interesting question. Should lives saved in the future be discounted for the purpose of calculating CPLS, or should they be counted the same as those saved tomorrow? To shed light on this, over the last year we have asked members of the public hypothetical questions that enable us to infer the rate at which they implicitly discount future lives saved (John K. Horowitz and Richard T. Carson [1990] asked similar questions of students). In the remainder of this paper, we summarize the results of this research, details of which can be found elsewhere (Cropper et al., 1991, 1992).

The author comments on an article by H. Elizabeth Peters concerning the impact of state laws particularly no-fault divorce laws on divorce rates in the United States. A reply by Peters is included (pp. 686-93). (ANNOTATION)

Income distribution and inequalities in the southern United States are analyzed and compared with data for the rest of the country. evidence presented in this paper reveals that in the 1970s the Souths income distribution either converged or moved significantly closer to the income distribution of the rest of the country. The degree of convergence depends on the definition of the recipient unit and to a degree on the particular cost-of-living index used to deflate Southern and non-Southern incomes. The convergence is attributed in part to the labor unionization in the Northeast and the resulting relocation of companies to the South. Data are from the 1970 and 1980 censuses and concern total household income. (EXCERPT)