Knowledge that Transforms

LIKE any livestock industry, the Canadian beef and dairy cattle industry is characterized by a cyclical pattern in terms of the number of cattle on farm, the number of cattle slaughtered and the number of cattle exported. Traditionally, the analysis and forecast of cattle stocks are based either on econometric models which often include the biological life cycle of cattle or on the pure biological nature of cattle.' In this paper, we investigate the behavior of the cattle industry through the use of a third approach-the Markov chain technique. The Markov chain technique is by itself a very mechanical procedure, but one which can incorporate economic justifications. It can then, in our view, provide a very fruitful view of the industry. Basically, the Markov chain technique allows us to construct flow matrices of beef and dairy cattle according to their biological sequences. For instance, a male calf born during any time period t can, in the same period, be slaughtered, exported, die or remain on farm as a calf. The decision to retain a calf as a steer (for future slaughter) or as a bull (for future reproductive purposes), to export the calf, or to slaughter the calf (for veal), is basically an economic decision. The outcome of such decisions is translated into the elements of the Markovian transition flow matrix. Based upon the biological sequences of the different categories of cattle and the structure of the beef and dairy cattle industry, we can set up transition matrices for Western and Eastern Canada. Table I indicates the structure of such matrices for Western Canada. Cells representing possible flows are identified by numbers while cells representing impossible flows are left blank.2 Transition probability matrices of cattle movement can be constructed by dividing each row element in the matrix by its corresponding row total. These probabilities reflect the probabilities of cattle moving from one category to another. It is also through the use of such probabilities that we will carry out our simulation analysis. This paper is divided into seven sections. In the second section a model of demand, supply and inventory for beef and dairy cattle is presented. Section III discusses some general empirical results based on the transition probability matrices. Section IV discusses the procedures for simulation using the conditional transition probability matrices. Section V presents the results of the historical simulation while section VI presents the results of some sensitivity analysis experiments. The last section is for concluding remarks.

D ESPITE acute interest in Monetary Approach to Balance of Payments (MBOP) over past several years, both as an explanation of worldwide inflationary epidemic of late 1960s and early '70s (Johnson, 1972b) and as a simple and manageable theoretical basis for policy recommendations by groups like IMF (Rhomberg and Heller, 1977), no general consensus has been reached as to validity of monetary model. One reason for this is that task of interpreting results of plethora of empirical tests of monetary approach' has been complicated by controversy over accuracy of exogeneity assumptions underlying MBOP that are implicit in those studies. These include exogeneity with respect to reserve flows of determinants of demand for nominal money balances-the domestic price level, interest rate and level of real income-as well as domestic credit component of a country's money supply. Exogeneity makes task of interpretation difficult, for if MBOP assumptions regarding exogeneity are incorrect, then, to borrow Geweke's (1978, p. 163) words (and to add studies in MBOP literature to which they would apply), the otherwise identifying restrictions imposed on structural equations may not be sufficient to identify those equations (Argy and Kouri, 1974; Genberg, 1976), estimation procedures will be inconsistent (e.g., Bean, 1976; Zecher, 1976), and model cannot adequately portray dynamics of system it seeks to describe. This last problem transcends any issue of estimation (although it is not unrelated) for it implies that theoretical specification of MBOP is incorrect to begin with, thus invalidating putative reduced forms of MBOP that have come to represent approach and form basis for policy recommendations alluded to earlier. Historically, exogeneity was simply assumed as something not amenable to testing. Recently, however, Geweke (1978) has demonstrated that specification of exogeneity is a hypothesis with testable implications. The purpose of this paper is to test formally exogeneity hypothesis underlying empirical tests of MBOP specifically, and theoretical specification of model in general, using Geweke's methods. It is found that hypothesis that variables mentioned above are in fact exogenous can be rejected for each and every country in sample. This finding casts some doubt on theoretical validity of MBOP and even more doubt on accuracy of much of empirical evidence garnered in its support. The plan of paper is as follows. In section II a MBOP model is briefly presented and its exogeneity restrictions are highlighted. In section III formal test of exogeneity is discussed, and then in section IV results of tests using data from Australia, France, Germany, Norway and Sweden are presented. Section V contains some conclusions.

Yutaka Horiba, Rickey C. Kirkpatrick, Factor Endowments, Factor Proportions, and the Allocative Efficiency of U.S. Interregional Trade, The Review of Economics and Statistics, Vol. 63, No. 2 (May, 1981), pp. 178-187

Traditionally, the empirical analysis of the effects of trade policy on resource allocation has relied both on a partial equilibrium framework using effective rates of protection and on a multisector general equilibrium framework. This paper responds to the growing dissatisfaction with the concept of perfect substitutability that has been assumed in these models. It discusses the theorectical properties and implications of one practical specification of product differentation and explores quantitatively the impact of trade policy on relative prices and resource pulls with a general equilibrium model that incorporates product differentiation. An analysis of the implications of product differentation for the autonomy of the domestic price system is extended to include intermediate products. The specification of imperfect substitutability provides a practical way of capturing product differentation both in a partial equilibrium and in a general equilibrium model. However, partial equilibrium based estimates are not likely to be robust when there are substantial policy changes that affect a number of sectors simultaneously.

A barrier to entry is a structural trait of a market implying that incumbent sellers can earn more than a normal rate of return without attracting entry (Bain, 1956; 1968, chapter 8). As regards capital costs, incumbents may have an absolute cost advantage because barriers to entry resulting from product differentiation, economies of scale, or impacted technological information increase the uncertainty enveloping the potential entrant's investment decision (Caves and Porter, 1977). This paper (1) advances two causes (other than fixed costs of entering markets for funds) for a pure capital-cost barrier to entry, (2) shows that barrier implies both (a) the coincidence of seller concentration with long-run excess profits and (b) a direct relation between concentration and excess profits even if the ability to coordinate price and nonprice rivalry were held constant over observed levels of seller concentration, and (3) provides evidence supporting the existence of such a barrier. In a market with multi-plant economies of in noncapital-raising aspects of production,' product differentiation, afsolute cost advantages other than those associated with capital costs, and financial markets which priced assets to provide an expected rate of return commensurate with risk, incumbent firms can elevate price above average costs without inducing entry if the post-entry capital costs for all firms in the industry exceed the pre-entry costs. Even in the absence of fixed costs of entering markets for funds, there are reasons for such a difference in costs. First, Sullivan (1978) has found that the systematic risk resulting from the stock market's revaluation of assets in response to new information is less for firms in concentrated industries than for those operating in more competitive markets. He suggests that may be because of the ability of large firms in concentrated industries to mitigate the adverse effects of new bearish information. His conjecture might be supported and extended by building oii the attempt of Salamon and Siegfried (1977) to establish links among elements of market structure and measures of political clout. For example, political influence might enable a firm to avoid the full impact of an economy-wide increase in taxes. Second, a different hypothesis is advanced in Scott (1977, 1980). Sullivan's work is based on the capital asset pricing model (CAPM), for which investors' general expected utility maximization problem has been reduced to a choice over two parameters of subjectively-evaluated probability distributions of returns. But, ceteris paribus,the probability distributions of returns in concentrated industries offer downside protection and upside potential relative to unconcentrated industries. That skewness could imply lower capital costs for firms in concentrated industries. To develop the skewness possibility, suppose that the stochastic process generating market demand is in general a Markov chain with large diagonal elements in the transition matrix.2 While that stochastic process together with existing capacity can imply the probability of capacity shutdown at any future time, adding market structure to the picture implies the probability thatfirms will exit during various periods of time. The probability that any given number of firms will exit varies inversely with seller concentration. Even if investors could diversify costlessly, the extra flexibility given market power to choose a profitable price and output in the face of a downturn in demand and the difference in costs-resulting from bankruptcy costs-for capacity shutdown versus firm exit can imply that capital costs fall as seller concentration increases. Thus, this paper suggests two reasons (other than Sullivan's political power speculation or fixed costs of transacting in financial markets) why the cost of capital of firms in concentrated industries could, ceteris paribus, be lower than for firms in unconcentrated industries. The two reasons follow from the fact that in an industry with fixed capacity and variable demand, a reduction in demand at a point in time may force firms to exit. But the probability of forced exit of a given firm is directly related to the number of firms in the industry. Hence, increased market concentration results in the reduced probability of forced exit. The reduction in that probability reduces capital costs by Received for publication January 23, 1980. Revision accepted for publication November 7, 1980. * Dartmouth College. I thank two anonymous referees of this REVIEW for very helpful comments on an earlier version of this paper. ' Thus by no economies of scale I do not mean costless and instantaneous adjustment to any point on a horizontal average cost curve. Capacity does come in discrete chunks (plants) for which we have the usual U-shaped cost curves. However, regardless of the number of these plants producing at minimum average cost that are combined to make a firm, unit cost is the same. Further, at the current levels of market demand, these units of capacity need not be large relative to the output of the market. That is, there need not be a scaleeconomies barrier in the sense of Bain. 2 Market demand has a high probability (but less than one) of staying where it currently is. If demand should fall, the fact that it is unlikely to rebound will force a reduction in capacity.

Allen, R. G. D., Mathematical Economics (London: Macmillan, 1956). Barnaby, F., Inevitable Conflict, New Scientist (August 25, 1979), 581-583. Hendry, D. F., and T. von Ungern-Sternberg, Liquidity and Inflation Effects on Consumers' Expenditure, in A. S. Deaton (ed.), Essays in the Theory and Measurement of Consumers' Behaviour (Cambridge: Cambridge University Press, 1980). McGuire, Martin C., A Quantitative Study of the Strategic Arms Race in the Missile Age, this REVIEW 59 (Aug. 1977), 328-339. Phillips, A. W. H., Stabilisation Policy in a Closed Economy, Economic Journal (June 1954). Sargan, J. D. Some Tests of Dynamic Specification for a Single Equation, Econornetrica 48 (May 1980), 879897.

Meghnad Desai, David Blake, Modelling the Ultimate Absurdity: A Comment on "A Quantitative Study of the Strategic Arms Race in the Missile Age", The Review of Economics and Statistics, Vol. 63, No. 4 (Nov., 1981), pp. 629-632