Knowledge that Transforms

A model of irreversible investment in a competitive industry under demand uncertainty is developed. In the absence of restrictions, investment by itself will keep the price from rising above a natural ceiling that exceeds the long-run average cost by an option value factor. When a lower ceiling is imposed, investment is triggered only by the observation of an even higher "shadow" price. As the imposed ceiling is reduced to the long-run average cost, this shadow price goes to infinity and investment ceases completely. Because investment is depressed, a tighter price ceiling generally leads to a higher long-run average price.

Optimal enforcement of law is examined in a model with specific enforcement effort--effort devoted toward apprehending individuals who have committed a single type of harmful act--and general enforcement effort--effort devoted toward apprehending individuals who have committed any of a range of harmful acts (a police officer on patrol, for instance, is able to apprehend many types of violators of law). If enforcement effort is specific, optimal sanctions are extreme for all acts. If enforcement effort is general, however, optimal sanctions rise with the harmfulness of acts and reach the extreme only for the most harmful acts.

The empirical results presented suggest that imperfect information is present in the Treasury bill market. The mean auction price for 3-month bills is, on average, four basis points below the comparable secondary market price for the 1973-84 period. This "downward biasing" is positively related to the anticipated amount of dispersion of auction bids. This suggests that auction bidders use a bidding strategy that accounts for their lack of agreement about the value of the bill. Further, the secondary bill market learns from the bill auction, implying that these two markets aggregate traders' private information differently.

A transaction costs framework is developed to explain the choice between lump-sum and per unit payment provisions in private timber-harvesting contracts. Predictions about which contract type minimizes the transaction costs of presale measurement and contract enforcement and monitoring are derived and tested using private timber sales contracts from North Carolina. The empirical results provide strong support for the transaction costs approach and also reject several predictions from a risk-based model. The transaction costs framework also provides insights into the choice between negotiated and competitive sales procedures.

This paper answers the efficient-turnover literature's long silence regarding the quit-layoff distinction. Treating quits as worker-initiated separations and layoffs as firm-initiated separations, I establish that the existence of layoffs is compatible with optimizing workers and firms forming and dissolving employment matches to exploit all the gains from trade. The efficient-turnover approach is shown to be consistent with many empirical regularities that distinguish quits from layoffs. Structural implications of the model are tested on data from the PSID.

This paper explores one possible explanation for the apparent excess volatility of production relative to sales: nonconvexities in the technology facing firms. It is shown that if firms operate in a region of declining marginal costs, then small shifts in demand can cause production to jump substantially. Estimates for six production-to-stock industries as well as the automobile industry suggest that all these industries behave as if they were operating in the region of nonconvex costs. The results have important implications not only for inventory investment but also for the cyclical behavior of productivity and prices.

Purchasing power parity is one of the most important equilibrium conditions in international macroeconomics. Empirically, it is also one of the most hotly contested. Numerous recent studies, for example, have sought to determine the validity of purchasing power parity using data from the post-Bretton Woods float and have reached different conclusions. We assert that most such studies are flawed for two reasons. First, the post-1973 data contain, by definition, only a very limited amount of the low-frequency information relevant for examination of long-run parity. Second, the dynamic econometric techniques used to model deviations from parity are typically quite crude with respect to admissible low-frequency dynamics. Both deficiencies are rectified in the present paper, with dramatic results. We construct a new data set of 16 real exchange rates covering more than a century of the classic gold standard period, and we study deviations from parity using long-memory models that allow for subtle forms of mean reversion. For each real exchange rate, we find that purchasing power parity holds in the long run.

This paper interprets seventeenth-century mercantilism in light of recent theories of strategic trade policy. Long-distance international commerce during the mercantilist period was undertaken chiefly by state-chartered monopoly trading companies and was therefore conducted under conditions of imperfect competition. The economic structure of the Anglo-Dutch rivalry for the East India trade provides an excellent illustration of an environment in which the profit-sharting motive for strategic trade policies exists. Dutch supremacy in the early East India trade was facilitated by a managerial incentive scheme in the monopoly charter that enabled it to achieve a Stackelberg leadership position against the English. Using data from the East India trade around 1620 in a Cournot duopoly model, I find that the managerial incentives yielded greater Dutch profits than would have been obtained from a standard profit-maximizing objective and that the scope for other strategic trade policies was clearly present.

This paper studies the political-economic equilibrium of a two period model with overlapping generations. In each period the policy is chosen under majority rule by the generations currently alive. The paper identifies a "politically viable" set of values for public debt. Any amount of debt within this set is fully repaid in equilibrium, even without commitments. By issuing debt within this set, the first generation redistributes revenue in its favor and away from the second generation. The paper characterizes the determinants of the equilibrium intergenerational redistribution and identifies a difference between debt and social security as instruments of redistribution.