Knowledge that Transforms

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.

Markets for many products are dominated by small group of states or countries with a natural advantage in the marketplace because of some initial endowment of resources, favorable climate, or location. The purpose of this paper is to explore how such markets involving a few political jurisdictions interact noncooperatively. We examine how such a market might be structured and operate and the extent of monopoly rent that can be extracted in the absence of collusion. We answer these questions for an empirically estimated model of western U.S. coal in which two states (Montana and Wyoming) dominate production. We demonstrate that in this market the amount of rent that can be extracted is greatly reduced through competition (relative to a cartel). Nevertheless, even with two producing states competing against each other, significant rents can be captured--significant enough to refute the contention that little rent can accrue without a cartel.

This paper examines the relation between nominal and real interest rates, and the nominal and real term structure under uncertainty. We show that two separate risk terms cause the Fisher theorem to fail. One risk term is related only to the variability of money prices, while the other is related to the purchasing power riskiness of the nominal bond. Monetary policy can affect the value of both these risk terms. We also show that the pure expectations hypothesis of the term structure fails for both real and nominal bonds because of risk premia. Even if the economy is neutral with respect to monetary policy, monetary policy can alter the nominal term structure.

This paper examines the existence of competitive equilibria in markets for exhaustible resources where there are initial economies of scale in either the extraction of the resource or the utilization of the resource as an input in production. In such instances, which are fairly common, we find that the classic Hotelling rule for competitive extraction does not apply, since competitive price equilibria generally do not exist. This is in marked contrast to static markets where the usual textbook example of firms with U-shaped average cost curves is not inconsistent with the existence of competitive equilibria. Furthermore, oligopolistic market equilibria in which resource firms act as Nash producers may also fail to exist when there are returns to scale in production.