Knowledge that Transforms

We analyze the efficiency and market equilibirum effects of endogenous categorization, where insurance companies classify risks on the basis of insureds' voluntary consumption of products that are correlated with underlying loss propersities, and we show that the use of such categorization may permit the attainment of first-best allocations as competitive Nash equilibria. The optimal insurance premium involves a trade-off between the use of categorization to correct moral hazard externalities generated by the consumption of the product and the use of differential consumption to sort heterogeneous consumers, thereby mitigating the social costs of adverse selection. The efficiency consequences of taxing or subsidizing aggregate, as opposed to individual, consumption is also considered.

This paper develops a simple model that shows how a country can endogenously become differentiated into an industrialized "core" and an agricultural "periphery." In order to realize scale economies while minimizing transport costs, manufacturing firms tend to locate in the region with larger demand, but the location of demand itself depends on the distribution of manufacturing. Emergence of a core-periphery pattern depends on transportation costs, economies of scale, and the share of manufacturing in national income.

We examine a decentralized monetary economy in which households can use a means of exchange (barter or gold) other than fiat money. The alternative means of exchange may drive out money even if monetary exchange Pareto dominates. Legal restrictions prohibiting other means of exchange may therefore be necessary. With stochastic preferences, households may use barter to supplement monetary purchases when they have an unexpectedly high demand. However, this may drive down the value of money (in all states) so low that households are again better off with fiat money alone. The paper provides both stochastic and nonstochastic examples in which eliminating markets for goods or assets that compete with fiat money improves welfare.

Are consumers effectively insured against idiosyncratic shocks to income or wealth, either by formal institutions such as charities, private insurance, and government programs or by informal mechanisms such as gifts and "loans" from relatives, friends, and neighbors? Under full insurance, consumption growth should be cross-sectionally independent of idiosyncratic variables that are exogenous to consumers. This proposition is tested by cross-sectional regressions of consumption growth on a variety of exogenous variables. Full insurance is rejected for long illness and involuntary job loss, but not for spells of unemployment, loss of work due to strike, and an involuntary move.

This paper presents new empirical evidence in support of the view that a significant fraction of total saving is motivated by the desire to leave bequests. Specifically, I find that social security annuity benefits significantly raise life insurance holdings and depress private annuity holdings among elderly individuals. These patterns indicate that the typical household would choose to maintain a positive fraction of its resources in bequeathable forms, even if insurance markets were perfect. Evidence on the relationship between insurance purchases and total resources reinforces this conclusion.

Currently, casinos and bookies use the point-spread method for betting on football games. Since an odds system is used in various other sports, what factors explain the current structure of the betting market? As the bookie's profits are a percentage of the total money wagered, the existence of point-spread betting indicates that the total money wagered under this betting scheme is greater than that generated by odds betting. This paper suggets that the current market structure is a consequence of risk-averse attitudes of bettors.

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.

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.

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.