Knowledge that Transforms

It has been almost 20 years since Phillip Areeda and Donald F. Turner introduced their proposals for antitrust policy toward predatory pricing. Their 1975 Harvard Law Review article, Predatory Pricing and Related Practices under Section 2 of the Sherman Act, sparked a lively debate among legal scholars and economists that continued, mostly in law reviews, for several years. The controversy focused on the core Areeda-Turner (AT) test, which put forward short-run marginal cost as the appropriate, but difficult-to-measure, standard of a lawful price and recommended reasonably anticipated average variable cost as a surrogate. The discussion included consideration of other cost-based measures, as well as alternative rules restricting dominant-firm pricing and output policies and both structured and open-textured rule-of-reason analyses. The controversy also helped to illuminate the qualifications that Areeda and Turner imposed on their proposal. One of the central issues in the debate concerning the AT test was whether or not it gave sufficient weight to the dynamic and strategic character of predatory pricing. All the participants in the discussion, including Areeda and Turner themselves, recognized that since the essence of predatory pricing is the predator's sacrifice of short-run gains for longer-run gains (and consequent harm to the public), the problem being addressed is inherently strategic. The lawyers and economists engaged in the debate differed, however, about whether anything practical could be done to cope with the intertemporal strategic issues. Areeda and Turner's reliance on a static model of dominant-firm behavior to derive their test reflected their doubt that a sound legal rule could be fashioned to cope with the inherently speculative and indeterminate assessment of longrun considerations. Curiously enough, just as the debate in the law reviews was winding down, the market-organization literature was beginning to see an infusion of contributions that used modern game-theoretic concepts and techniques to analyze well-specified models of strategic firm behavior in oligopolistic markets. In particular, several important contributions analyzed models of markets in which predatory pricing emerged as part of a set of equilibrium strategies. These contributions effectively undermined the view that, because of its costs to the would-be predator, predation is irrational and hence not likely to occur. This work is well categorized and well surveyed in the chapter that Janusz Ordover and Garth Saloner (1989) contributed to The Handbook of Industrial Organization. A central feature of this class of models is some asymmetry of information between market actors. The dominant incumbent firm is better informed than its smaller rival in models where the predator induces exit of competitors; the incumbent is better informed than potential entrants in models where predation takes the form of entry deterrence; and firms in general are better informed about their prospects than are their sources of financing. The new market-organization literature on predation offered three major types of models. First, there were well-developed game-theoretic analyses of the long-purse or deep-pocket theories of predation, theories which Lester G. Telser (1966) had analyzed earlier in a perfect-information tDiscussants: Paul Joskow, Massachusetts Institute of Technology; Joseph Stiglitz, Stanford University.

Theories of the demand for money typically predict that the quantity of money demanded will increase when: (a) the rate of return paid on money (if any) increases, (b) the rates of return paid on alternative assets decrease, or (c) the of operations (as measured by income, wealth, spending, or permanent income) of the relevant economic actor (firm, household, or nation) increases. Regarding (c), the choice of the most useful measure of involves the guidance of two competing but overlapping concepts of money's role. Transactions models (going back at least to Irving Fisher [1911]) are based on the idea of money as an inventory that bridges the gap created by nonsynchronous receipts and expenditures. For economic actors of a given the optimal inventory should be determined by the opportunity cost of money-holding, the pattern of receipts and expenditures, and the technology of money management. Given these factors, that inventory should increase as the scale, as measured by the rate of receipts or expenditures, rises. Portfolio models (going back at least to John M. Keynes [1930] and popularized by Milton Friedman [1956]) are based on the analogy between asset-holding and budgetary decisions by consumers. The portfolio manager faces a menu of alternative assets with various risk and return characteristics and a given net worth. The optimal holding of money (or any asset) depends upon this wealth constraint, the characteristics of the menu items, and his or her preferences. An increase in wealth should, in general, lead to an increase in money-holding, the magnitude of which depends upon the relative of money as a portfolio component. Such theories suggest that a measure of wealth is the single most useful variable, although the rate of transactions may enter indirectly as a determinant of the otherwise unmeasured marginal return to money. Estimated demand schedules should presumably be based on the most useful scale variable, and some policy issues depend on the choice.1 This choice has been addressed a number of times by studies exploiting time-series data. Table 1 summarizes the results of six regressions from three studies which have approached the question in a nearly uniform way. In equation (i) Alan Meltzer (1963) uses wealth as the variable for aggregate data with great success. The addition of an income measure in (ii) yields no appreciable increase in explanatory power. An equation with income only (not shown) is very similar to (i). The fit is very slightly poorer. In (iii) Charles Lieberman (1977) uses debits to demand deposits as a measure of transactions. The addition of a wealth measure in (iv) yields little additional explanatory power. In (v) Robert Rasche (1987) uses GNP velocity in a first-difference regression. Adding wealth in (vi) yields no significant improvement. Meltzer interprets his results as evidence of the superiority of a portfolio approach. Lieberman interprets his results as evidence of the superiority of the transactions approach produced by a more useful measure of transactions. Rasche favors the use of transactions velocity.

As has often been observed, support for free trade and opposition to protectionism are the prescriptions for economic policy that are the most broadly, if not universally, shared among professional economists. Indeed, even those few who would argue for interventionist trade policies in selected circumstances would be hard pressed to find a persuasive rationale for most existing trade interventions as enhancing the usual conception of a nation's general economic welfare. For instance, it may be possible to construct a logically tight case for supporting, with subsidies or temporary trade protection, some high-technology industries that are expected to generate positive nonpecuniary externalities within the national economy. The naive might even believe that real-world political processes actually allow most governments to implement consistently such beneficial interventions, without opening the door to a host of more dubious activities. However, surveying the range of actual trade interventions of, for example, the United States, it is difficult to see how import restraints for textiles, steel, or automobiles are allowing dynamic comparative advantage to be developed in these industries; and the same may generally be said for many of the protectionist policies of other nations. It is on such specific issues, would emphasize, rather than on the abstract principle of absolute free trade, that the practical and important battle over freer trade versus increased protectionism is actually won and lost. Thus, as the keynote for this paper, it is fair to ask the following question: if economists have so long and so generally agreed about the virtues of freer trade and the evils of protectionism, why have we not been more effective in persuading others of the merit of our position. As see it, the situation is rather like that faced by a famous preacher who recently called his congregation together to pray for an end to the long California drought. My friends, he said, I want to thank you all for coming here today, when so many others might ridicule our efforts. But, have for you a question. You all know why we are here. What want to know is-where is your confidence? Where is your belief? Where is your faith? Where are your umbrellas? Similarly, as economists imbued with the true faith and preaching the virtues of freer trade, we need to ask: why do we not more consistently inspire other people to take up the intellectual umbrellas that guard against the evils of protectionism? On this question, would first like to offer one important qualification, then consider two relevant answers, and finally conclude with three suggestions.

Under Pigouvian third-degree price discrimination, a profit-maximizing monopolist typically charges different groups of customers different prices (resale between groups is assumed to be impossible). These differences in price entail a loss of efficiency because marginal valuations of the output are not equal across buyers. The net welfare effect of allowing price discrimination is ambiguous though, because the total output under discrimination may exceed that under uniform pricing. Nevertheless, under quite general conditions, third-degree price discrimination by a monopolist can increase (static) welfare only if total output is greater under discriminatory pricing than under uniform pricing (Richard Schmalensee, 1981; Hal R. Varian, 1985; Marius Schwartz, 1990). Although there has been much analysis of whether price discrimination raises or lowers total output or welfare, the size of these effects has remained largely unexplored. Varian (1985) compares discriminatory pricing to uniform pricing for a monopolist and provides some bounds for the change in welfare in terms of market prices and outputs; but these relationships give little sense of the relative size of welfare changes resulting from third-degree price discrimination. I address this issue by asking what can be said about the ratio Wd/ Wu, where Wd and Wu denote welfare under discriminatory and uniform pricing, respectively (welfare is measured as the sum of producer surplus and Marshallian consumer surplus). Section I provides two examples showing that this ratio can range from zero to infinity. In these examples, all markets are served under uniform pricing, and demand in one of the markets is strictly convex. Considering a two-market model in which a monopolist with constant marginal cost serves two independent markets under uniform pricing, I show in Section III that if demands in both markets are concave, then Wd/ W, is bounded below by 2. (The assumptions of constant marginal cost and independent demands allow producer surplus and consumer surplus to be identified separately for each market. Separability across markets is central to the approach taken in this paper.) Following Joan Robinson (1933), I call a market (weak) if the discriminatory price in that market is at least as great as (no greater than) the profit-maximizing uniform price. Surprisingly, the key to bounding Wd/ WU is that the demand function in the weak market be concave. If one market is strong, the other is weak, and demand in the weak market is concave, then Wd/ W' can be bounded above by 2.5 (or even 1.75 or 1.6 with additional assumptions on the demand functions). These bounds arise for several reasons. First, the monopolist's profit under uniform pricing must be at least as large as the profit in the weak market under discrimination. Moreover, if at all prices demand in the strong market is as great as in the weak market, then profit under uniform pricing must be at least twice as great as profit in the weak market under discrimination (otherwise the monopolist could do better by charging the monopoly price for the weak market). Second, this relationship between profits in the two markets is useful in bounding welfare because welfare in each market can be related to profit in that market. Section II shows that if demand is con* Department of Economics and A. B. Freeman School of Business, Tulane University, New Orleans, LA 70118. I thank Marius Schwartz and two anonymous referees for their comments on earlier drafts of this paper.

To explain the slow progress of mass privatization programs in Eastern Europe, the authors present a model based on a positive spillover between aggregate privatization and the individual expected return to privatization, derived from a potential populist backlash if costly reforms do not bring forth sufficient aggregate privatization. The model allows for the simultaneous existence of a pessimistic zero-privatization trap and an optimistic full-privatization equilibrium defined by a critical mass of expected privatization. While both privatization subsidies and minimum-income guarantees can by themselves secure coordination on the optimistic equilibrium, the financing constraint may offset the direct effect.